BASEL II: PROBLEMS AND USAGE

An aftermath of the crisis was the enactment of the Banking Ordinance
of 1986, which became fully effective on September 1, 1988. The
Ordinance strengthened the regulatory framework of the three-tier banking
system and, more importantly, stipulated the minimum liquidity ratio and a
minimum capital adequacy ratio of 8 %. Other international practices recommended
by the Basel Committee were also adopted and enforced in subsequent
years. The banking system has been quite stable for most of the
time since the adoption of the Basel framework of banking supervision and
the linked exchange rate system. This is particularly the case when compared
with earlier banking development in the previous two decades. 45
From this perspective, it can be argued that the stricter banking regulation
has contributed to banking stability, because there has never been any systemic
banking crisis in subsequent years (Leuven and Valencia 2008). Even
the Asian Currency Crisis did not cause any bank or AI to fall through. 56
In fact, the last bank failure in Hong Kong was the collapse of the Bank of
Credit and Commerce International (BCCI) in 1991. 67
Nonetheless, the collapse of BCCI triggered runs on Dao Heng Bank,
Citibank and Standard Chartered Bank. Most people, particularly regulators,
view bank runs as signs of banking instability, because bank runs are
socially costly. More recently, there was a run on the BEA in September
2008 shortly after the outbreak of the financial tsunami. Therefore, as far as
bank runs are concerned, the banking system is not entirely immune from
instability despite the implementation of the Basel regulatory framework.
However, the latest run on BEA, however, may not necessarily be bad
at all. On the contrary, it can be interpreted as a sign reflecting the fundamental
soundness and stability of the Hong Kong banking system. First of
all, the run was not contagious as it had not spread to other healthy banks
and triggered a systemic panic. Instead, it can be viewed as an efficient run
that exercises strong market discipline for enhancing overall banking stability
in the longer run. One can say that unfounded malicious rumors were
the culprits causing the run on BEA and also point the finger at rogue
speculators. But the run was not entirely baseless. In fact, BEA had loans
4 In its evolution into an international financial center, Hong Kong was occasionally
hit by financial crises. Besides the banking crisis of 1982-1986, another system-wide
banking crisis occurred in 1965 (see Jao 1974 for details), which led to the enactment of
the Banking Ordinance of 1964. Prior to this regulatory reform, the Hong Kong banking
system was highly unregulated, if not a pure free banking system (see, for example, Chu
1996).
5 A large investment bank, Peregrine, and a handful of stock brokerage firms did
go bankrupt. However, they were not subject to the supervision within the Basel framework
like banks.
6 BCCI’s business in Hong Kong was solvent, although its overseas parent failed.
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