Hong Kong: Private Emergency Loans, 1965

HSBC and Chartered Bank acted as private lenders of last resort by deploying emergency loans in response to local deposit runs. The bank runs in 1965 coincided with a collapsing stock market and real estate bubble. Local Chinese banks faced widespread exposures to increasingly illiquid assets, in particular, unfinished property developments (Schenk 2003). Beginning with the run on, and subsequent failure of, Ming Tak Bank in January 1965, waves of deposit withdrawals affected several local Chinese banks. The 1965 banking crisis illustrated a flight to quality in which depositors demanded currency from local Chinese banks while increasing their deposits in more reputable foreign banks (Goodstadt 2005). The British note-issuing banks, HSBC and Chartered Bank, benefited from the flight to quality and, therefore, were in a strong position to support distressed banks. The support was purely reactive in stopping runs once they had materialized and used to prevent widespread bank failures among local Chinese banks (Jao 1974, 246–48).

Hong Kong’s quasi currency board system operated with HSBC and Chartered Bank as the sole private issuers of domestic currency backed by British sterling assets, although the government also issued a negligible quantity of currency (Jao 1974, 141). Article 10 of the Hongkong and Shanghai Banking Corporation Ordinance (Cap. 70) provided HSBC with the authority to “issue, re-issue and circulate notes of the bank (HSBC) payable to bearer on demand,” exclusively within the Hong Kong region. Unlike HSBC, Chartered Bank received the authority to issue notes through its charter of incorporation rather than by ordinance (McCarthy 1985).

The passage of the 1964 Banking Ordinance authorized the newly established banking commissioner to impose prudential controls (e.g., regulating financial reporting and liquidity requirements), but the banking system continued to operate without a central bank (Jao 1979). The role of LOLR fell to HSBC and Chartered Bank during the 1965 crisis; these two banks previously acted as LOLR during a much smaller panic in 1961. As the licensed note-issuing banks, HSBC and Chartered Bank could supply banks experiencing runs with currency backed by British sterling assets (Jao 1974, 141).

Following the failure of Ming Tak Bank in January 1965, HSBC extended emergency loans to Canton Trust amidst the second wave of deposit runs in early February. The forced closure of Canton Trust shortly thereafter spurred additional runs on other local Chinese banks. Although HSBC and Chartered Bank publicly offered unlimited support for these affected banks, deposit withdrawals persisted; see Key Design Decision No. 17, Communication, for a discussion of the wavering promises of unlimited support (Jao 1974, 247). As a result, the government introduced the Emergency (Bank Control) Regulations on February 9, effective February 10 (Government of Hong Kong 1966; Jao 1974, 247).

First, the government imposed a daily limit of HKD 100 (roughly USD 17.3) on cash withdrawals from accounts at local banks, although payments by check continued. It declared British sterling notes a temporary legal tender in Hong Kong. Next, under the regulations, the financial secretary could require banks to report daily cash balances to the banking commissioner, who could then force banks to hand over surplus banknotes to the licensed note-issuing banks, HSBC and Chartered Bank (Jao 1974, 247).

The February 1965 emergency liquidity provisions alleviated depositors’ fears, and within one week the government was able to lift restrictions on cash withdrawals without resurgent bank runs (Jao 1974, 247). Moreover, Schenk (2003) notes that the government removed the withdrawal restrictions after receiving a shipment of sterling notes from London, which were ultimately never circulated.

A third phase of bank runs erupted on April 9 when news circulated of investigations into Hang Seng Bank, the largest local Chinese bank. HSBC quickly responded by acquiring Hang Seng Bank at the request of the government. Schenk (2003) notes that the announcement of HSBC’s acquisition—complemented by emergency loans for other vulnerable banks, provided by HSBC and Chartered Bank—quickly restored confidence amongst depositors.

The government also provided liquidity injections to struggling banks using its sterling reserves in London (Jao 1974, 261). To augment domestic liquidity, the government could transfer some of its sterling reserves, held in London, for deposit with Hong Kong banks.^FNThese injections were largely secretive, and our research has not found explicit disclosure of the mechanics of these injections during 1965. However, the government provided similar injections in 1967 through HSBC to support the distressed Bank of China (Schenk 2009). In this arrangement, the government placed a GBP 10 million seven-day deposit with HSBC; HSBC could then increase note issues or lend to the Bank of China with its additional sterling funds (Schenk 2009). Since Hong Kong’s quasi currency board arrangement required all HKD to be backed by sterling, sterling inflows provided for additional note issues and domestic lending (Goodstadt 2007, 185; McCarthy 1985).

The banking commissioner acted as the prudential supervisor in Hong Kong. The 1964 Banking Ordinance required licensed banks to produce monthly financial materials (selected balance sheet and income statement figures) for the banking commissioner. The banking commissioner also had the authority to inspect and take over licensed banks (McCarthy 1985).

The financial secretary managed Hong Kong’s Exchange Fund, a large portfolio of international reserves used to ensure the full backing of the HKD’s exchange rate. As of 1965, the HKD was informally linked to British sterling, which composed almost all of the Exchange Fund’s assets (McCarthy 1985).

Despite being private banks, HSBC and Chartered performed special roles in Hong Kong. They served as the sole issuers of private banknotes (HKD) (Jao 1974, 141). HSBC, the largest bank in Hong Kong, also managed Hong Kong’s clearinghouse, helped the government maintain the official exchange rate, and served as lender of last resort. The role of HSBC as the manager of Hong Kong’s clearinghouse enabled it to use the banking system’s surplus reserves to assist banks in settling balances. According to Goodstadt (2005), HSBC could use the surpluses of the banking system “free of charge” to lend to illiquid banks “at commercial rates” to cover deficit balances.

After the failure of Canton Trust created public outrage and panic, the government became determined to combat subsequent bank runs (Goodstadt 2007, 150). Once a run ensued on a local bank, the government requested either HSBC or Chartered Bank to intervene, typically through pledging emergency loans. Whenever HSBC or Chartered announced their willingness to support a bank experiencing deposit runs, they emphasized that support would be unlimited (Jao 1974, 246–48). With little disclosure of these lending arrangements, it is difficult to determine most of the mechanics of these interbank loans and the extent of the government’s involvement.

To issue notes, HSBC or Chartered transferred sterling assets to the Exchange Fund and received certificates of indebtedness (CIs) valued at par in HKD (McCarthy 1985; Nugée 1995). All banknotes had to be backed by either CIs or the note-issuing banks’ own sterling assets; in practice, almost all notes were backed by CIs, and the amount of notes backed by banks’ sterling was limited to HKD 30 million (Jao 1974, 141; McCarthy 1985). The Exchange Fund provided these HKD certificates in a ratio of HKD 16 per GBP (Nugée 1995). HSBC and Chartered could also redeem the certificates of indebtedness for sterling under par (0.84% spread) at the Exchange Fund.^FNSource states that the CI redemption rate was 1 shilling and 2.75 pence per HKD, implying a 1.67% spread. By 1965, the spread had halved (Nugée 1995). The government, however, agreed to abolish this spread during the 1965 crisis (Nugée 1995).

At the start of 1965, there were 87 licensed banks in Hong Kong, 38 of which were local Chinese banks and 49 foreign-owned, including those owned by the Chinese state (Goodstadt 2007, 159). Local Chinese banks experiencing runs were the only recipients of emergency loans (Goodstadt 2005).

Although foreign banks in Hong Kong inherited the prudential norms of their native financial systems, local Chinese banks operated with minimal supervision. The first statutory liquidity requirement established in 1964 forced many local Chinese banks to liquidate assets to become compliant (Schenk 2003).

As indicated in Key Design Decision No. 5, Administration, HSBC and Chartered Bank were able to fund HKD liquidity support using the CIs they received after depositing sterling assets with the Exchange Fund (McCarthy 1985; Nugée 1995). Aside from their note-issuing powers, the two banks also benefited from their relatively insulated financial positions during the deposit runs. When the crisis emerged, HSBC and Chartered Bank were conservatively managed and less exposed to real estate assets (Goodstadt 2005; 2007, 154); HSBC maintained this conservative reputation by aiming for a 50% liquidity ratio while the industry slipped below 30% (Schenk 2003; 2004). Consequently, while many local Chinese banks experienced deposit withdrawals in 1965, the two banks benefited from a “flight to quality;” in the first half of 1965, HSBC and Chartered Bank’s deposits increased 17% and 18%, respectively (Goodstadt 2005). Figure 1 depicts the deposit growth experienced by the two British colonial banks, HSBC and Chartered, which helped fund emergency loans to banks facing runs (Goodstadt 2005).

Figure 1: Deposits for Banks in Hong Kong during the First Half of 1965 (HKD Millions)

The government accumulated large fiscal surpluses, which were deposited in sterling accounts in London. The government could transfer these funds into the colony, increasing the supply of the reserve currency used to back HKD liquidity (Goodstadt 2007, 186, 189). During April and May in 1965, the government transferred reserves from London into the the Hong Kong banking system to provide additional liquidity support for various distressed local banks (FEER 1966, vol. 52, 67–69; Jao 1974, 261).

Measured in terms of certificates of indebtedness—which HSBC and Chartered received when transferring sterling to the Exchange Fund for the right to issue currency—note issues totaled HKD 354 million during the crisis period (Nugée 1995).

At its peak, emergency liquidity provided by the government to local banks amounted to HKD 163 million, HKD 104 million of which was channeled through HSBC (Goodstadt 2005, footnote).

At first, HSBC extended limited support in the amount of HKD 25 million to Canton Trust amidst its deposit run (Schenk 2003). While the public perceived HSBC’s support for Canton Trust as being unlimited, HSBC subsequently corrected the record and noted that unlimited support would be impossible. Thereafter, deposit runs intensified, resulting in the closure of Canton Trust and the spread of contagion to other local Chinese banks (Jao 1974, 246). Following Canton Trust’s failure, HSBC and Chartered Bank declared “unlimited support” as they each extended emergency loans to these distressed banks (Jao 1974, 246).

The exact rates charged on emergency loans to vulnerable banks were not publicized. However, Goodstadt (2005) notes that HSBC—in its role as LOLR—charged “whatever overnight rates the market would bear” during panics. During 1965, interbank interest rates ranged from 5.0% to 7.4% annually, peaking during the months of January and February (Government of Hong Kong 1969; Jao 1974, 76). In 1965, HSBC’s deputy chief manager, Oliphant, stated that HSBC and Chartered Bank provided LOLR cash loans at commercial rates (FEER 1965, vol. 48, 177).

Additionally, the 0.84% spread that the Exchange Fund charged HSBC and Chartered for the redemption of CIs (which were noninterest bearing) for sterling represented a cost for these banks to provide HKD liquidity (McCarthy 1985; Nugée 1995). With the high demand for currency at the beginning of 1965, HSBC and Chartered petitioned the government to remove the spread for the stability of the banking system. The government agreed to the demands and abolished the spread, allowing HSBC and Chartered to more freely issue banknotes during the crisis (Nugée 1995).

The limited publication of financial data makes it challenging to identify the collateral used to secure emergency interbank loans from HSBC and Chartered Bank during the 1965 crisis. However, Oliphant described the various types of collateral accepted for LOLR support as “mortgageable assets, securities, foreign balances or secured advances” (FEER 1965, vol. 48, 177). At the time, banks in Hong Kong did not have access to a functioning bond market, and the government managed its budget without issuing any Treasury bills, limiting the available collateral options (Jao 1974, 74).

During crises, emergency loans were most likely secured by a range of illiquid bank assets, as evidenced in the bank runs of 1961—a smaller crisis to that of 1965 also caused by the bursting of a real estate and stock market bubble (Schenk 2003). HSBC and Chartered Bank provided emergency loans to Liu Chong Hing Bank during a deposit run in 1961. Jao (1974, 239) notes that the terms of the loans were not publicized; however, leaked information suggested that real estate assets collateralized the transactions.

To collateralize HKD banknote issues, HSBC and Chartered Bank deposited sterling cash with the Exchange Fund. Under this arrangement, HSCB and Chartered Bank credited the Exchange Fund’s account with sterling and received HKD CIs at the official rate (Schenk 2009).

Despite the limited disclosure of lending arrangements, the details of phase four of the 1965 crisis suggest considerable accommodation for maturities and duration of lending activity. After HSBC’s acquisition of Hang Seng Bank, the banking disturbances stabilized, and the period of mass bank runs ended. However, in November 1965, a minor run ensued on Far East Bank, which, at the time, was the only licensed bank operating in violation of the liquidity requirement. Although the imminent failure of the bank did not necessarily threaten the system as a whole, HSBC, at the government’s request, extended emergency loans to Far East Bank. HSBC’s financial support continued into 1969 when Far East Bank was eventually taken over by another bank (Jao 1974, 249).

Due to the lack of transparency surrounding the terms of emergency loans, we find no additional conditions aside from those previously identified.

As mentioned in Key Design Decision No. 3, Part of a Package, the government deployed a series of emergency liquidity measures on February 9 and 10 as bank runs continued to spread amongst local Chinese banks. Among the measures, the government declared British sterling notes as temporary legal tender in Hong Kong to accommodate the large demands on Hong Kong currency. This was followed by the importation of GBP 20 million sterling notes that were ultimately never circulated (Schenk 2003). Both Jao (1974, 247) and Schenk (2003) note that the provision for additional currency options in the form of sterling notes relieved the present currency shortage and prevented a cash crisis.

In the initial deposit runs on Ming Tak Bank and Canton Trust, the government allowed the banks to fail and took them over, which was consistent with the colonial government’s laissez-faire banking policy. While Ming Tak Bank was amongst several unlicensed banks in Hong Kong, Canton Trust was officially licensed by the government, and its failure drew considerable public backlash from the bank’s 100,000-plus depositors. Goodstadt (2007, 150) notes that the failure of Canton Trust marked a turning point for the government’s approach to bank runs: from then on, the government aggressively combatted runs and tacitly ensured depositors’ protection. Still, the repayment of depositors took time. For the remainder of the crisis, the government quickly intervened in bank runs, typically by requesting that HSBC and Chartered Bank provide unlimited emergency loans to distressed banks (Jao 1974, 246–49).

Because the 1965 banking crisis was confined to Hong Kong’s unique financial system, similar liquidity interventions did not take place in other countries.

HSBC and Chartered Bank typically announced emergency loans for distressed banks over the radio and in newspaper advertisements (Jao 1974, 247). During the run on Ming Tak, the first bank run of the year, the banking commissioner published a statement that emphasized the isolated character of the panic, which did not threaten the otherwise sound banking system. Similarly, during the second phase of the crisis, the financial secretary made an announcement that there was sufficient liquidity in the banking system. However, the government’s messaging did little to restore confidence in vulnerable banks (Jao 1974, 245–46).

HSBC first intervened in the 1965 crisis during the run on Canton Trust; the run subsided once HSBC communicated its intention to extend HKD 25 million in emergency funding to Canton Trust (Schenk 2003). Within one day of this announcement, however, HSBC issued a clarifying statement after realizing that the initial LOLR pledge had “unfortunately been misinterpreted to mean that [HSBC] was giving the Canton Trust unlimited support, which was impossible” (Jao 1974, 246). Following the clarification, runs on Canton Trust resumed and the bank was forced to close; thereafter, HSBC and Chartered Bank announced unlimited support when extending loans to banks facing runs.

Our research could not determine the specific lending terms including rates, collateral, and loan maturities. In his coverage of HSBC and Chartered Bank’s emergency loans during the 1961 bank runs, Jao (1974, 239) notes that lending terms were not disclosed; the same situation might have applied to the 1965 intervention. However, throughout the crisis, HSBC and Chartered Bank publicized each recipient of emergency loans. When a local Chinese bank experienced a run, either HSBC or Chartered Bank responded by announcing financial support. As a key feature of the emergency loans, these announcements utilized the reputations of the two large British banks in an attempt to assure creditors of distressed local banks (Jao 1974, 246–47).

Additionally, we have identified the amount lent to individual banks on two occasions in 1965: the runs on Canton Trust in February and on Far East Bank in November. Before its failure, Canton Trust received a loan of HKD 25 million from HSBC (Schenk 2003). Similarly, Far East Bank borrowed more than HKD 40 million in emergency loans from HSBC. Notably, another bank acquired Far East Bank years later with some portion of these obligations still outstanding (Jao 1974, 249). In these instances, the loan amounts may have been disclosed only after the failure of Canton Trust and the acquisition of Far East Bank.

The government also did not disclose specifics of its liquidity support to distressed banks. A letter from the banking commissioner to the financial secretary on September 2, 1965, revealed peak outstanding liquidity injections from the government, which totaled HKD 163 million (9.7% of local Chinese banks’ combined liquidity) (Goodstadt 2007, 155, 271). It is difficult to determine the mechanics of this support, which Goodstadt (2007, 155) describes as “secret injections.”

Throughout the crisis, HSBC and Chartered Bank extended emergency loans in order to stop deposit runs on local Chinese banks. At the beginning of the crisis, the initial announcement of HSBC’s loan to Canton Trust helped assure depositors and temporarily stopped the run (Jao 1974, 246). As discussed in Key Design Decision No. 17, Communication, following HSBC’s clarification on the limits of its lending, future announcements of emergency lending proved less effective in averting runs. Nevertheless, HSBC and Chartered made sure to publicize subsequent lending in bank runs, demonstrating the absence of a stigma strategy in the emergency loans (Jao 1974, 247).

The exit from emergency liquidity support provided by the government, HSBC, and Chartered Bank did not follow a predefined strategy and was rather dictated by incidences of withdrawals from local Chinese banks. As private LOLRs, HSBC and Chartered responded to runs on various local banks by pledging emergency loans for individual banks facing runs; since such support constituted interbank loans, it did not follow a uniform policy with specific exit dates (Jao 1974, 246–47). As for the government’s emergency liquidity policies introduced in February, research could not determine whether such announcements included exit strategies. While the emergency provisions imported GBP 20 million in British sterling notes authorized as temporary legal tender, the government found no need to ever circulate these notes as liquidity shortages affected local Chinese banks rather than the system as a whole (Schenk 2003). However, the assurance of emergency liquidity in the form of sterling notes enabled the government to promptly eliminate the temporary restriction on cash withdrawals within one week of its introduction (Jao 1974, 247). As such, the exit from the withdrawal restriction coincided with the physical delivery of sterling notes in Hong Kong (Schenk 2003).

The continued support HSBC and the government offered through 1965 and well into 1966 provides further evidence for the absence of an exit strategy. Although the waves of widespread bank runs ended by the third phase of the 1965 crisis in April, HSBC and the government supported two small banks in November 1965 and September 1966 (Jao 1974, 249–50).

Hong Kong’s government also established permanent structural changes in 1965 following the episodes of bank runs in order to prevent similar panics in the future. These 1965 changes can be thought of as anticompetitive regulations protecting local banks, including a moratorium on new bank licenses that lasted through 1981 and the formal adoption of a cartel amongst licensed banks to fix interest rates on deposits^FNPrior to the government’s formal adoption of the cartel in 1965, HSBC organized an unofficial interest rate cartel to protect Hong Kong banks from competing for deposits by hiking interest rates (Goodstadt 2006a). (Goodstadt 2006a). Scholarship has routinely criticized the government’s pursuit of anticompetitive banking policies following the 1965 crisis. Schenk (2006) argues that such anticompetitive legislation addressed a misguided belief that Hong Kong was “overbanked” while failing to remedy the source of the 1965 crisis, namely, the failure of local banks to adhere to prudential norms. Similarly, Goodstadt (2007, 171) criticizes the 1965 structural changes for providing little benefit to local banks through protectionist policies rather than developing a better system for prudential supervision.