Issues Facing the HKMA

Speeches

17 Apr 1997

Issues Facing the HKMA

David Carse, Deputy Chief Executive, Hong Kong Monetary Authority

(Speech at the Association of Corporate Treasurer)

Ladies and gentlemen,

I am pleased to be here this lunchtime to talk to you about some of the issues facing the HKMA.

For those of you who are not familiar with the work of the HKMA, the easiest way to describe our role is that we are effectively the central bank of Hong Kong. This is sometimes not totally clear to the outside world because the HKMA is not a legal entity in its own right but is part of Government. However, our functions and objectives are very much in line with those of other central banks around the world. These are:

  • first, to maintain currency stability;
  • second, to promote the safety and stability of the banking system through our banking supervision;
  • third, to promote the efficiency, integrity and development of the financial system, particularly payment and settlement arrangements.

The first of these needs a little more elaboration. In most countries the central bank objective of maintaining the stability of the currency is expressed in terms of domestic prices, that is control of inflation. In Hong Kong, however, given the open nature of the economy and its heavy reliance on trade, the objective is to maintain the external value of the Hong Kong dollar against the US dollar through the linked exchange rate system.


The transition and beyond

As you would expect the specific issues confronting the HKMA at present fall broadly within these three categories. Let me start by confronting the issue of the forthcoming change of sovereignty about which we get endless questions from people outside Hong Kong. There are really two issues here: the short-term question of whether there will be any disruption to financial markets in the run-up to the handover and the longer term issue of how the system will operate thereafter and the role of the HKMA.

On the first issue, we expect the transition to be a smooth one. However, we cannot afford to be complacent. Hong Kong's foreign currency reserves of US$66 billion give us substantial financial strength to fight off professional speculators. But they represent only about 35% of Hong Kong dollar deposits, 14% of stock market capitalization in Hong Kong and around 9% of the value of property. It is therefore vital that we maintain the confidence of both foreign investors and the people of Hong Kong. Fortunately, at present there are objective and valid grounds for optimism in this regard:

  • the Hong Kong dollar is continuing to trade normally on the strong side of the US dollar. Its value does fluctuate within narrow limits, influenced by such factors as the demand generated by fund managers as they switch funds into or out of the stock market. However, we are not seeing capital flight out of the territory induced by political concerns;
  • indeed, growth in Hong Kong dollar deposits has remained buoyant with an increase of 24% in the year to February 1997. Overnight Hong Kong dollar interest rates have remained close to their US dollar equivalents. Liquidity of the local currency is therefore plentiful and in talking to foreign banks, it appears that the concerns that they were expressing a year or so ago about the availability of Hong Kong dollars, is no longer an issue;
  • the willingness of foreign banks to participate in long-term syndicated loans to Hong Kong companies and the declining margins on these, plus the enthusiasm of some foreign banks to engage in residential mortgage lending in Hong Kong are practical demonstrations of confidence;
  • the same confidence is being displayed in the capital markets and the property markets, although the prospect of further rises in US interest rates is having a dampening, but perhaps timely, impact on equity and property prices. One noteworthy fact is the yield on the Exchange Fund's 10-year notes currently stands at 50 basis points over the equivalent US Treasury bonds compared with 89 basis points on 31 December 1996.

Of course, confidence can be a fragile thing and we cannot take it for granted. It has to be acknowledged that the Hong Kong does not receive a good press outside the territory and this can affect sentiment, including that of head office management of banks and other companies who have a presence here. This is why the HKMA has spent a considerable amount of effort in trying to spread a positive, but realistic, message about the monetary arrangements which will apply after the handover. In particular, Joseph Yam and Chen Yuan, the Deputy Governor of the People's Bank, have conducted a series of road-shows to London, Tokyo, New York and Frankfurt to present the post-1997 arrangements to audiences of bankers. This has been done with the cooperation of the central banks in these countries. It is an extremely vital task, because the fact is that the framework that will apply after 1997 has simply not been well understood outside Hong Kong. I hope that our efforts have helped to get the message across.

What is that message? I do not have to go into a lot of detail before a local audience such as this, but let me summarize some of the main points which arise from the Basic Law and the understandings on implementation reached with the Mainland:

  • first, the Hong Kong dollar will continue to circulate freely after 1997 as the only legal tender in Hong Kong. It will remain backed by the assets of the Exchange Fund and linked to the value of the US dollar. I should add that this latter point is not part of the Basic Law, but is one on which there is general agreement between the authorities in China and Hong Kong;
  • second, monetary policy and practice in Hong Kong will be a matter for the future SAR Government, and specifically the HKMA. Deputy Governor Chen Yuan has repeatedly made it clear that the PBoC will not take the place of the HKMA;
  • third, in the same way, banking supervision in Hong Kong will remain the responsibility of the HKMA. Mainland banks operating in Hong Kong will continue to be treated as foreign banks and will not be given preferential treatment in Hong Kong. The same principle will apply to Hong Kong banks operating in China.

Our view is that the framework derived from the Basic Law provides a viable way forward for the future monetary relations between Hong Kong and the Mainland. Our frequent contacts with Mainland officials give us every reason to believe that the arrangements will be respected, and we are working on the basis that they will be. If, contrary to our expectations, the promised autonomy is not delivered, then market participants will take note of that and it will become more difficult to achieve the objective of maintaining Hong Kong's position as an international financial centre.

It is worth noting that this objective is not simply an aspiration. It is a legal requirement actually built into the Basic Law that the SARG shall provide an appropriate economic and legal framework for the maintenance of the status of Hong Kong as an international financial centre. This is not the sole responsibility of the HKMA, but it is one of our major preoccupations. The particular areas on which we are focusing are as follows.


Banking Supervision

Hong Kong is the host to over 330 foreign banks from over 40 countries. It is essential that they operate within a supervisory regime which offers them a level playing field and where the rules of the game are widely-known and clearly expressed. It is particularly important that these rules are in line with international standards. The fact is that overseas regulators are becoming increasingly reluctant to see their banks establishing themselves in jurisdictions where supervisory regimes are lax and where secrecy laws can be used to hide dubious transactions. Our aim therefore is to provide Hong Kong with a supervisory system which is commensurate with its international status. In recognition of that status, we have been invited by various international bodies to help formulate international supervisory standards. For example, the HKMA recently participated in a working group to produce a set of Core Principles for Effective Banking Supervision. These principles will set the standard by which the supervisory systems of individual countries and territories will be judged, for example by bodies such as the International Monetary Fund. It is intended that the final version of the Core Principles will be presented to the international financial community at the IMF/World bank Meetings in Hong Kong in September of this year.


Financial infrastructure

The success of a financial centre depends in large part on the quality of its infrastructure, particularly its payments and settlements systems. Financial activity will tend to move to those centres where the transaction costs are lowest and where the transactions are most secure and can be delivered in real time. This, and the need to ensure the stability of the domestic financial system, is why the HKMA introduced the Real Time Gross Settlement System for interbank payments in December 1996. This was a high risk project in the sense that the consequences of a failure of the system would have been disastrous for the smooth functioning of the money market. I am glad to say however that the project was successfully launched on time and has functioned without any major problems since then.

Domestically, RTGS has provided the building block for real-time Delivery versus Payment in the debt securities market through its link to the HKMA's book entry transfer system for securities. This in turn can lead to linkages with other payment and settlement systems abroad, thus enabling Payment versus Payment for foreign currency transactions and Delivery versus Payment for securities transactions across international boundaries. All this fits into our strategic objectives for Hong Kong. A stable framework for payment and settlement between countries in the Asian region will promote increased financial intermediation across frontiers which Hong Kong will be particularly well-equipped to handle. In other words, Hong Kong will benefit if the size of the financial cake in the region becomes bigger, and particularly if Hong Kong can get a bigger share of that cake.

The prospects for the debt market in Hong Kong will depend not only on robust settlement arrangements, but also on a supply of good quality paper. We hope that one of the domestic catalysts for this will be the Mortgage Corporation which will start operation in the second half of the year. As you are probably aware, the Corporation will buy residential mortgages from the banking system, thus relieving the concentration risk of the banks in property and adding to the liquidity of their balance sheets. The Corporation will finance itself either by issuing debt securities on the strength of its own balance sheet or by securitising the mortgages it has acquired. It is hoped that this paper will help to meet a rising demand for high quality debt securities by institutional investors in Hong Kong.


International cooperation

Achieving the objective of promoting the status of Hong Kong as an international financial centre is not something that we can do in isolation. It requires us actively to seek cooperative links with other parties, such as foreign central banks and multilateral financial institutions. This participation serves a number of useful purposes.

  • first, it helps to keep Hong Kong in the forefront of financial and monetary developments, and gives us a chance to influence such developments;
  • second, membership of bodies such as the Bank for International Settlements is a practical recognition of Hong Kong's importance as a financial centre and support for its autonomy after 1997;
  • third, by raising the profile of the HKMA, it underscores the fact that we will continue to be in charge after the handover and that there will not be any vacuum in monetary control in Hong Kong;
  • finally, it helps in achieving concrete results in such areas as linking together payment and settlement systems in the region and strengthening our mutual defences against speculative attack.

The most manifest sign of our efforts towards promoting international cooperation will be the IMF/World Bank meetings to be held in Hong Kong in September. This holding of the Meetings here is a major vote of confidence in the continued success of Hong Kong as an international financial centre. The HKMA is responsible for the coordination of all local planning and implementation work for the Meetings, and as you can imagine this is presently one of our major preoccupations. We are confident that the Meetings will prove to be a great showcase for Hong Kong.


Conclusion

This has been a quick run-through of some of the issues with which the HKMA is currently dealing. There are two themes which link them all together. The first is the concern for stability - in the currency, banking and payments system areas - which all central banks share. The second is the need to reinforce and promote Hong Kong's position as an international financial centre and thereby ensure its prosperity after 1997.

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Last revision date : 17 April 1997