Bank Resolution Regime – A Newly Established Line of Defence for Banking Stability


10 Aug 2017

Bank Resolution Regime – A Newly Established Line of Defence for Banking Stability

After several years of hard work of the HKMA, relevant Government departments and other supervisory authorities, the Financial Institutions (Resolution) Ordinance (the Ordinance) was passed in June 2016 and has come into effect on 7 July 2017.  Hong Kong is currently one of the few jurisdictions within Asia that has in place a resolution regime that is fully compliant with international standards.  The Ordinance confers upon the HKMA, as the resolution authority for the banking sector, new statutory responsibilities and powers to enable it to manage future bank failures in an orderly manner should such events occur in future.  

The establishment of a resolution regime in Hong Kong has great significance for banking stability.  However, to most readers, this may be a dry topic about distant events which will hopefully never happen.  Nevertheless, we think that it is necessary to introduce to the general public this concept because should a bank fail in a disorderly manner, it has the potential to affect all of us in society, rich and poor.  It may also have an adverse impact on Hong Kong’s status as an international financial centre.  So, even though resolution is a technical subject, it is important for us all to have an idea of what it means, how it will impact us directly and how resolution protects us all from disorderly bank failure. I will also discuss the HKMA’s progress in operationalising the resolution regime for banks and our plans to help make bank failure an orderly event.

Whilst bank failure in Hong Kong is rare, the HKMA cannot be complacent when it comes to protecting Hong Kong’s financial stability.  A key lesson from the global financial crisis (GFC) of 2008 is that regardless of the size of the bank, it is possible for it to fail, and insolvency is not a desirable mechanism for managing the orderly failure of a bank as in the case for other types of firms.  This is because once a bank enters insolvency, it would need to suspend all operations. The general public and businesses would not be able to withdraw their deposits or access other critical banking services, resulting in the disruption to credit and lending flows in the market. This would lead to erosion or even breakdown of public confidence in the banking system, posing systemic risk.  The larger and the more systemically important a bank is, the more acute and widespread the consequences of its entry into insolvency will be.  Consequentially, this creates the phenomenon that some sizable banks have become “too big to fail” (TBTF). 

This is why during the GFC many foreign governments were forced to use large sums of taxpayers’ money to bail-out TBTF banks when they ran into difficulties.  For example, the UK Government injected GBP133 billion to rescue banks on the brink of collapse, while the US Government disbursed over USD400 billion of taxpayers' money under the Troubled Asset Relief Program to bail out troubled banks.  In order to make up for the astronomical amount of money spent on these substantial bail-outs, most of the governments concerned had to cut public spending (e.g. reduction in national budget for hospital services and education).  The fact that taxpayers had to pick up the tab for the failure of profit-minded commercial enterprises has understandably led to public backlash, the effects of which we are still feeling today.  It has also called into question the merits of an open and globalised financial system.

Post-GFC, leaders of the G20 countries learnt from the experience and reached unprecedented international consensus to address the TBTF problem by establishing resolution as a major part of the global bank regulatory agenda.  In 2011, the Financial Stability Board established new international principles (known as the “Key Attributes”) on resolution regimes, which sets standards and rules for the orderly management of bank failure.

The Ordinance, which is modelled on the Key Attributes, arms the HKMA with powers necessary to deal with bank failures in a quick and decisive manner, minimising the consequences and the contagious effect, thereby protecting the Hong Kong financial system, on which the wider economy depends.  The Ordinance will help to ensure that the critical services provided by a failing bank will continue, especially deposit and lending services to the general public and small and medium-sized enterprises.  The Key Attributes also make clear that bail-out of a failed bank with public funds while its shareholders and certain creditors remain shielded from loss will no longer be tolerated.  The HKMA, together with the relevant international counterparts, will work with banks to structure their businesses in a way such that if banks were to fail in the future, their failure could be managed in an orderly manner.  This will mean the cost of bank failure will be internalised and end the use of taxpayers’ money to foot the bill. 

One of the key resolution powers provided to the HKMA is ‘bail-in’, which is a way to recapitalise distressed bank so that its shareholders and certain creditors will bear the losses of the failure, obviating the need for any injection of public funds.  The HKMA may use this power to write-down the bank’s liabilities (including its equity, capital and liabilities), or convert them into equity, thereby offsetting the losses of a failed bank, essentially giving it an equity ‘boost’ and improving its financial condition.  By aligning the interests of a bank with those of its shareholders and creditors, this arrangement creates a stronger incentive for these interested parties to constantly monitor and constrain the risks the bank is taking today to avoid future failure.

Now that the Ordinance is in force, the HKMA is equipped with a fuller set of tools to mitigate the impact of bank failure.  However, to ensure the genuine effectiveness of the resolution arrangements, the HKMA must work with the banks to prepare and plan for resolution.  Generally, banks may need to make changes to their legal, financial and operational structures to remove impediments to resolution.

To facilitate the implementation of this new resolution regime, the Resolution Office has been established within the HKMA in April this year.  Its priorities are: establishing resolution policy standards for the banking sector, developing bank-specific resolution strategies and assessing the feasibility of resolution plans prepared by banks, working with banks to remove impediments to an orderly resolution, and preparing for the implementation of resolution.

The bail-in power described above is a key aspect of an orderly resolution.  However, as bail-in only applies to certain types of liabilities in a bank, we must introduce rules to ensure that banks have enough loss-absorbing capacity (LAC) for bail-in.  In other words, LAC is a precondition to the use of bail-in power, and to protecting taxpayers’ money.  But of course bank shareholders and creditors must be treated fairly, which is why the Ordinance provides a guarantee that no shareholders or creditors would receive worse treatment through use of the bail-in power than if the bank had gone into insolvency.  The HKMA plans to conduct a public consultation on its proposed LAC policy on banks at the beginning of 2018.

The HKMA will continue to promote the general stability and effective working of the banking system through its day-to-day supervision.  However, we cannot rule out the possibility of bank failure in the future, for example due to unforeseen events across the globe.  As an open economy, we must plan well in advance and prepare for the worst.  While the failure of a large bank will never be costless or painless, we will endeavour to make it orderly and fair.  With the introduction of the Ordinance, the relevant authorities are vested with powers to make shareholders and creditors, not taxpayers, bear the cost of the next crisis.  We have made significant progress; now we need to complete the implementation of LAC and other necessary resolution reforms to give bank shareholders and creditors clarity in relation to their treatment.  The successful implementation of the Ordinance will be a key step in helping to maintain Hong Kong’s continued status as an international financial centre.

Norman Chan
Chief Executive
Hong Kong Monetary Authority

10 August 2017

Latest inSight
Last revision date : 15 August 2017