"Managing the Liberalisation Process"
Speech By Mr Lim Hng Kiang, Deputy Chairman MAS, Minister For Health and Second Minister for Finance, at the Association of Banks in Singapore AGM Dinner on 25 Jun 2002
1 The last five years have been challenging ones for our banking sector. Whether facing the direct impact of the Asian financial crisis or the aftershocks of the South American and Russian financial crises, it is clear that financial services is a global industry. Singapore emerged relatively unscathed but the lesson was clear. No country can insulate itself. Least of all, a small country like Singapore.
2 MAS began to liberalise the domestic banking sector in 1999, and introduced further liberalisation measures in 2001. We had to move away from the protected environment in which our local banks operated. Protection was unsustainable and incompatible with the long-term interest of Singapore. It was far better to pro-actively manage the introduction of competition. The local banks would be spurred to upgrade without being overwhelmed by the competition, and the economy would benefit from world-class banking services provided by quality international banks.
3 Three years later, liberalisation has permanently changed the landscape of the banking sector. We now have six Qualifying Full Banks with the ability to reach out more widely to retail customers through branches and offsite ATMs. Our local banks have responded to the competition by improving their product offerings and investing in new technologies and systems. They have consolidated into three larger entities with greater scale to compete at home and abroad.
Impact of Liberalisation on Consumers
4 Competition in the new, liberalised environment has brought consumers many benefits. Technology has been harnessed to produce new service channels such as internet banking, phone banking and self-service banking centres. In some instances, these provide consumers with a suite of services exceeding those available at branches.
5 Competition has also driven down the prices for many banking products and services. In the mortgage loan market, for example, intense competition has meant lower mortgage interest rates for homebuyers. But in some other areas, fees and charges have risen. This is because competition also means that banks have to watch their costs and bottom lines more closely. Banks have also had to rationalise their branch networks, to achieve greater cost effectiveness.
6 This is a process of adjustment for both banks and consumers. Consumers are entitled to expect banks to provide high standards of service while keeping prices affordable. But they must gradually get accustomed to paying for services which used to be provided free. On their part, consumer banks - especially the local banks and the QFBs - must realise that they have an obligation to service the mass market, so that lower-income Singaporeans have access to affordable banking services, just as nearly every household in Singapore can afford a telephone and utilities services provided at market rates.
7 I commend the Association of Banks in Singapore (ABS) for taking the initiative to develop the banking code of practice and to set up the Consumer Mediation Unit. These are important steps to reassure the public of the industry's commitment to quality service and high standards of fairness and transparency. In particular, the Consumer Mediation Unit will assure customers that they have an independent avenue for redress outside the courts that is impartial, quick and affordable. The industry now has to ensure that the standards in the banking code are effectively enforced by member banks and the mediation unit functions well to meet the needs of customers. The industry should also continue to periodically review its service standards to ensure they are in line with international best practices.
8 Last year, MAS called on the industry to address consumer concerns on costs and access. I am pleased that ABS has reached a consensus on the main features of an affordable Basic Bank Account. I understand that ABS has put this initiative on the fast track, with details to be announced within the next two months, and implementation early next year. I would encourage ABS to make use of this time to have discussions on the account with key stakeholder groups such as CASE and NTUC to explain the underlying economic rationale and ensure that the features meet the needs of customers.
9 These voluntary initiatives by the industry to assure customers of continued access to affordable quality banking services are positive steps which merit encouragement. A banking sector that understands its role in the market and is responsive to the needs of its customers offers the best assurance that the interests of consumers will be met. The alternative to this is government regulation, compelling banks to provide by law a specified package of services to the public. A number of other countries have chosen this path, but its disadvantage is inflexibility: once the package is fixed, it cannot easily be changed to adapt to changing needs and conditions. This will impose burdensome costs on the industry, and ultimately will serve the interests of neither banks nor consumers. In my view, the banking industry should be given the opportunity to make the various industry initiatives announced today succeed.
Deposit Insurance in a Sound Banking System
10 Just as the liberalised banking sector has prompted calls for an assurance of quality basic banking services at affordable cost, it has also prompted a review of whether depositor protection should be further strengthened.
11 Last year, MAS announced that it was studying whether a deposit insurance scheme would be desirable and feasible in Singapore. Deposit insurance schemes have been implemented in over 70 countries, including the US, UK, Canada, and most European countries. The features vary, but they all share the common purpose of providing an assurance to depositors. This takes the form of a guarantee to depositors that they will be compensated up to a maximum specified amount of their deposits in the unlikely event that the bank they had placed their deposit with fails. This guarantee is backed by an insurance fund that is built up through premium contributions from each participating bank, and which will be drawn upon to meet payouts to depositors.
12 Why would we need a deposit insurance scheme when our banking system is stable and sound? Indeed, might the mere act of introducing a deposit insurance scheme give depositors the mistaken impression of some heightened risk in our system? MAS considered these issues very carefully.
13 Depositors with banks in Singapore have always been secure in the knowledge that that our banking system is strong and well-supervised by the MAS, which has acquired a reputation over the years for being a strict regulator. The three local banks are well-managed and amongst the best-capitalised in the world. The QFBs operating here have met high prudential standards for admission. MAS remains steadfast in maintaining high standards of regulation and supervision even as we take a more consultative and risk-focussed approach to supervision.
14 Whilst our banking system remains sound, we are operating in an increasingly challenging global and regional environment. The business of banking has grown more complex, and so has risk management. As foreign banks gain greater market share in Singapore and local banks further develop their presence abroad, the soundness of banks operating here will increasingly be affected by factors beyond our control.
15 Vigilant supervision can minimise the probability of bank failure but cannot eliminate the risk of failure entirely. Even in reputable foreign jurisdictions with highly-regarded supervisors, bank failures occur from time to time. With sufficient warning signals, a supervisor may be able to ring-fence assets in Singapore of an ailing bank, and so reduce the losses suffered by its creditors, but this may not always be possible. Depositors cannot assume they will always be protected from losses.
16 MAS has concluded that a deposit insurance scheme is suitable for Singapore. A deposit insurance scheme will provide a further layer of protection to depositors and complement the role of prudent bank management and MAS supervision in minimising risk. Indeed, studies by the IMF have found that an increasing number of countries have established deposit insurance as an integral part of their financial safety net, and that a well-conceived deposit insurance scheme reinforces confidence in the banking system.
17 MAS also believes that this is a good time to implement deposit insurance in Singapore. A recent study by the Financial Stability Forum covering more than 100 countries has found that the introduction of a deposit insurance scheme will be most effective when the country's banking system is healthy. Thus, far from being a measure that is necessary only in bad times or in a weak banking system, a deposit insurance scheme should be put in place when the banking system is strong and sound. This is the same with any insurance policy. We take out medical insurance when we are hale and hearty and so enjoy low premiums. By the time we are sick, insurance cover will not be available or it will be provided at a prohibitive cost. Many of us will consider the premiums well spent for the extra peace of mind even if we hope never to make use of it.
18 A deposit insurance scheme also makes explicit the extent of protection that depositors can expect. It dispels the mistaken impression that depositors may have, in the absence of an explicit deposit insurance scheme, that the government has provided an implicit guarantee and will bail them out in the event of a bank failure. Such a guarantee can pose risks to the stability of the banking system by undermining market discipline. Depositors would lose the incentive to seek out sound banks, and banks would lack discipline to manage their business prudently, taking comfort that public funds will be made available to bail them out. This is what economists call "moral hazard". The consequence is a less stable banking system, and a greater likelihood of something going seriously wrong. Clearly, this would be against the interests of both banks and depositors.
19 Having explained why a deposit insurance scheme is desirable, I now turn to the objectives that this scheme should serve. First, it should provide a basic financial safety net aimed at small depositors. Second, the cost of this scheme should be kept low for banks and depositors. Third, it should differentiate between stronger and weaker banks so that incentives are created for banks to improve their risk profile. I will elaborate on each of these in turn.
A Basic Safety Net
20 As is the case in many other countries, Singapore's deposit insurance scheme should be aimed at small depositors and therefore provide specific and limited protection. This can be achieved by setting a maximum coverage amount. A depositor is assured of getting back in full his deposits with a failed bank up to this maximum coverage limit. Deposit amounts above this coverage limit are not guaranteed. Thus, while small depositors can expect to enjoy full protection of their deposits, large depositors may experience some loss beyond the maximum guaranteed amount.
21 The vast majority of small depositors maintain relatively modest balances with their banks. About 80% of individuals maintain balances below $15,000 to $20,000. Hence, a coverage limit of this amount would afford adequate protection to the majority of small depositors. Large depositors on the other hand can reasonably be expected to make their own assessments and be subject to the caveat emptor principle when putting their money with a bank of their choice. Also generous coverage weakens the incentive for large depositors to exercise market discipline on banks and encourages banks to take excessive risk.
A Low Cost System
22 MAS is very mindful of the need to keep deposit insurance affordable. Like all insurance plans, deposit insurance is not free. Participating banks have to contribute towards building up the deposit insurance fund to stand behind the guarantee. The higher the level of coverage, the higher the cost. Banks might find the Singapore market commercially unviable to operate in or they could pass on the additional costs to depositors. It is therefore critical to keep the cost of deposit insurance low whilst achieving the objective of providing effective protection to the majority of small depositors.
23 A coverage limit of between S$15,000 and S$20,000 can be provided at a relatively modest cost and should not significantly impact the cost of deposit-taking.
Differentiating Between Banks
24 Apart from keeping the cost of deposit insurance low, MAS is also mindful of the need to allocate the funding of deposit insurance equitably among contributing banks. Some deposit insurance schemes levy flat rate contributions on banks. Under a flat rate regime, all banks are charged a uniform rate on the deposit base. A flat rate contribution structure, while simple, has its disadvantages First, it does not recognise differences in the risk profiles of banks and hence the differing level of expected losses that each bank exposes the deposit insurance fund to. Well-managed, highly-capitalised banks would in effect be subsidising riskier banks for the insurance cover the latter enjoy. Second, flat rate contributions do not provide an incentive for banks to improve their risk profiles in order to enjoy lower contribution rates.
25 MAS is studying a system of risk-based contributions. Deposit insurers in the US and Canada have implemented risk-based contribution systems. Under a risk-based system, insured banks are assigned to different contribution categories in accordance with their risk profiles and their ability to manage their risks. Each category of banks is charged a different contribution rate, with banks in the best category paying the lowest rate.
Public and Industry Consultation
26 Deposit insurance is a major initiative. Although deposit insurance is already well established in many mature economies, the concept and mechanics of an explicit but limited guarantee on deposits is new to Singaporeans and will require careful explanation. It will be effective only if it is well understood by depositors. Thus, even though the study is on-going and may take another year to complete, MAS will communicate key concepts and features of the deposit insurance scheme to the public periodically. MAS will also actively consult with banks on the design of a scheme that is cost-effective, equitable, and bolsters confidence in our banking system.
27 The first phase of MAS' deposit insurance study will make preliminary proposals on participating deposit-taking institutions, coverage limit, fund size and risk-based contributions. MAS expects to complete the first phase by August and will consult extensively with the industry and the public on these issues.
28 Three years ago, MAS embarked on a process to liberalise the banking sector. The aim was to develop a more competitive and dynamic environment that promotes innovation and enterprise. Whilst this has brought many positive changes, it has also raised concerns about the quality and affordability of basic banking services to small depositors. I am happy that the ABS has responded positively by developing the banking code of practice, setting up the Consumer Mediation Unit and offering the Basic Bank Account. In addition, the introduction of a deposit insurance scheme will strengthen our banking sector further. With all of us working together, I am confident we can develop a competitive banking sector that can hold its own in the global market.