The crisis lesson that the HKMA still hasn't learned

The crisis lesson that the HKMA still hasn't learned


Yesterday Hong Kong Monetary Authority boss Norman Chan Tak-lam outlined his views on the future of financial sector regulation following the crisis of 2008.

It wasn't a gripping speech; no one was sitting on the edges of their seats in excitement. But excitement isn't really what you want from a central banker. Careful, cautious deliberation is nearer the mark.

On the whole that's what Chan delivered. Where he did take a policy stance, rather than making broad generalisations, most of what he said was eminently sensible.

But it was what he didn't say that was really interesting - and worrying too.

Chan, who succeeded long-time HKMA chief Joseph Yam Chi-kwong late last year, was on stage at Credit Suisse's investment conference alongside former Japanese vice-minister of finance Eisuke Sakakibara, for a post-crisis discussion on lessons learned and the road ahead.

Old Sakakibara was in no doubt which direction financial regulators should take to safeguard financial system stability in the future. The Volcker rule has to be imposed, he thundered, calling for the swift implementation of a proposal devised by former US Federal Reserve head Paul Volcker under which deposit-taking banks would be forbidden from engaging in activities deemed too risky like proprietary trading.

To his credit, Chan's view was more nuanced. Although all in favour of tighter regulation of the financial sector, he was justifiably dubious about knee-jerk responses like the Volcker plan.

As Chan pointed out, prohibiting banks from proprietary trading - dealing in markets for their own accounts rather than on behalf of customers - would be impractical. It can be almost impossible to distinguish proprietary trading from market-making from balance sheet management.

An overly heavy-handed approach to regulation, he warned, would merely push risky activities out of the banks, making them more reliant on short-term funding from the relatively unregulated shadow financial system, adding to, rather than reducing, overall systemic risk.

The key to preventing the next financial bubble, said Chan, is for regulators to limit the degree of leverage in the financial system. This is sensible thinking. It was because of the rapid build-up of leverage in the US financial system over the years leading up to 2007 (see the charts) that the damage was so devastating when asset prices began to decline.

As a result, Chan pledged to keep a close eye on the amount of credit extended to Hong Kong's property sector. We want to make sure banks don't relax their underwriting standards, he said.

Chan's approach to preserving financial system stability is commendable. What is troubling is that while discussing financial regulation after the crisis he focused exclusively on systemic stability and never once mentioned customer protection.

This is worrying, because if there is one lesson the HKMA boss really should have learned from the financial crisis, it is that while Hong Kong's supervision of banking system stability is relatively solid, our regulatory protection of bank customers is woefully inadequate, as the Lehman minibond scandal demonstrated.

In fact, the HKMA's over-emphasis on systemic stability proved actively harmful to ordinary bank customers. It was because of concerns over the financial strength of Hong Kong smaller banks' following the dismantling of the interest rate cartel in the late 1990s that the HKMA encouraged them to increase their fee income, for example by selling complex structured products to depositors. To be fair to Chan, the HKMA has no mandate to safeguard the interest of bank customers. Nor is it clear that the HKMA is the right body to look after their interests. As the minibond example shows, there is a fundamental conflict of interests between supervising systemic stability and regulating for consumer protection. What's good for banks may be bad for their customers.

As a result, Hong Kong needs a separate regulator with the teeth to supervise banks' conduct and safeguard the interests of their customers. This could be a new banking ombudsman, or possibly a beefed up Securities and Futures Commission with its responsibilities extended to cover customer protection across the whole financial sector.

This is the real lesson Hong Kong's regulators should have taken away from the financial crisis. Judging from Chan's remarks yesterday, it hasn't yet been learned.



tom.holland@scmp.com