The Lender of Last Resort

The Hong Kong Monetary Authority (HKMA) will soon be issuing a detailed policy statement on the HKMA's role as lender of last resort to all authorised institutions in Hong Kong, according to the Chief Executive Mr Joseph Yam.

Mr Yam was speaking at the Hong Kong Association of Banks' Half-Yearly Dinner in Hong Kong today (29 June).

The detailed policy statement will address the HKMA's role as lender of last resort, which involves the provision of support to banks that are basically solvent but are troubled by short-term funding difficulties. This function is to be distinguished from the provision of intra-day liquidity under the Real Time Gross Settlement System and overnight liquidity through the Discount Window. It is also distinct from the provision of longer-term liquidity or capital support to a probably insolvent bank.

Mr Yam said that the HKMA had acted as Hong Kong's official lender of last resort since its establishment in 1993, although it had never had to exercise that function.

The Banking Sector Consultancy Study commissioned by the HKMA last year found that a large number of participants in the banking sector were either unaware that there was actually a lender of last resort or were unclear as to the conditions under which the HKMA would provide such assistance.

"There are strong justifications for the HKMA not only to restate the principles under which we are ready to provide liquidity support to institutions experiencing difficulties, but also to further clarify the objectives, the mechanics and the limits of this support," said Mr Yam.

"A greater knowledge and awareness of the availability of a lender of last resort facility will, we hope, further help to reduce uncertainty, and will in turn help to improve overall market liquidity in the event of future crises, should they arise," he added.

Mr Yam said that a formalised policy framework would also help the HKMA itself to ensure speed and consistency in considering whether or not to extend lender of last resort support.

The resources for providing lender of last resort support would be drawn from the Exchange Fund in accordance with the Exchange Fund Ordinance. The HKMA's exercise of lender of last resort support would also be consistent with the Currency Board arrangements in Hong Kong.

The basic precondition for obtaining support was the systemic risk that would arise from the failure of a troubled institution if it were deprived of liquidity assistance.

"The guiding principle in considering whether to provide lender of last resort support to an individual authorised institution is whether the failure of that institution, either by itself or through spreading contagion to other institutions, would damage the stability of the exchange rate or the monetary and financial systems," Mr Yam said.

In addition to this basic precondition, a number of other preconditions would need to be satisfied by an institution seeking support. These included : a sufficient margin of solvency, adequate collateralisation, and a demonstration that the institution had already sought other reasonably available source of funding.

The HKMA would use three basic instruments to provide support: purchase of the institution's placements with other banks; repos of eligible Hong Kong dollar securities; and a credit facility against the security of the institution's residential mortgage portfolio.

"We believe that the provision of these details will go a long way towards removing market uncertainty and improving market liquidity, especially in times of crisis," he said.

Hong Kong Monetary Authority
29 June 99

*The LOLR policy statement has been amended in March 2009. Please refer to the press release "HKMA to continue the provision of liquidity assistance to banks" issued on 26 March 2009.