How will Hong Kong's proposed revision of the resolution regime impact bank creditors?

There is a lower likelihood of government support for banks.

Moody's Investors Service says that the Hong Kong government's proposed revision of its bank resolution regime will have varying impact on different classes of bank creditors. The revision will broaden the government's policy toolset to resolve distressed banks, including the ability to impose losses on bank creditors through bail-in.

"The government intends to minimize the use of public funds in the future resolution of failing financial institutions," says Sonny Hsu, a Moody's Vice President and Senior Analyst. "Such a move indicates a lower likelihood of government support for banks."

Here's more from Moody's:

The government has announced that all customer deposits covered by the local deposit protection scheme will be excluded from future bail-in, regardless of the deposit protection ceiling. The exclusion from bail-in for protected deposits will subject other creditors to greater potential losses.

Certain types of deposits, such as structured deposits, time deposits with maturities of more than five years, bearer certificates of deposits, and deposits held by the overseas and Mainland branches of Hong Kong banks, are not covered by the deposit protection scheme, and will therefore be subject to potential future bail-in.

Nevertheless, the government may decide to exclude all deposits — regardless of deposit protection coverage — from bail-in in future bank resolutions, given concerns over possible contagion. The imposition of losses on unprotected depositors could trigger a loss of confidence in other Hong Kong banks, leading to an outflow of funds and a weakening in other Hong Kong banks' liquidity profiles.

In addition, overseas authorities may refuse to recognize Hong Kong's resolution actions if the territory's authorities give preference to Hong Kong depositors over overseas depositors. Such a refusal could interfere with the Hong Kong government's resolution objectives.

As such, Moody's expects to maintain alternative sets of assumptions if and when Moody's adopts its advanced "Loss Given Failure" (LGF) framework to assess the credit risk of Hong Kong banks' liabilities. One set of assumptions will follow the liabilities ranking in line with the government's proposed resolution regime, with deposits covered by the deposit protection scheme excluded from potential bail-in.

The alternative assumption — where the government decides to exclude all customer deposits from bail-in, regardless of whether such deposits are covered by the local deposit protection scheme — will result in non-deposit senior unsecured debt creditors being exposed to higher potential losses than is the case if only deposits under the protection scheme are excluded from bail-in.

The adoption of the advanced LGF framework will depend on whether Moody's considers the passage of the proposed bank resolution legislation as likely, whether the legislation possesses sufficient clarity such that Moody's can clearly assess the credit implications for creditors, and whether government support for banks will indeed be predictably less forthcoming under the revised regime.