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Monetary Affairs in Hong Kong: Recent Developments and Outlook

by Joseph Yam, Chief Executive, Hong Kong Monetary Authority

(Speech at the American Chamber of Commerce Luncheon, reprinted in the HKMA Quarterly Bulletin Issue No. 10)

12 December 1996


The Long March

On 23 September 1997, the International Monetary Fund and the World Bank will be holding their annual meetings here in Hong Kong. I am sure there will be great excitement in Hong Kong, particularly in the financial sector. In the annual meetings themselves there will continue to be sharp focus on the many development issues facing many economies. On the fringes of the meetings there will be the usual enormous volume of businesses concluded and opportunities for opening up more.

The great majority of the finance ministers and central bank governors of members of the IMF and the World Bank will be here also to witness the stability and prosperity of Hong Kong as an international financial centre within China under the framework of "one country, two systems". The 250 brand new Mercedes and the customary bodyguards serving them, and many more limousines of equally famous brands for other VIPs and guests will flow around the new extension of the Convention and Exhibition Centre, immaculately built. The Chinese leadership will be here in great numbers to reiterate their commitment to retain Hong Kong's capitalist system and perhaps also take the opportunity to gain greater insight into how a free market economy works. I am sure these important visitors will be pleased to see Hong Kong.

I hope also that the people of Hong Kong, notwithstanding the inconvenience that they may be put to, will feel rather euphoric about the event. My staff at the Hong Kong Monetary Authority and myself, being charged with the responsibility to organize the event, will by that time, that is the 23 September 1997, feel old and tired, but happy about efforts well spent on an event that we hope will go down in history as one of the best organized for the annual meetings of the World Bank and the IMF.

All this will be in great contrast to what happened and to the mood of Hong Kong on that same day of 23 September fourteen years ago in 1983. There was near panic amongst the people of Hong Kong and there were queues waiting to get into supermarkets. Yes, it was the day that the Hong Kong dollar touched 9.60 to the US dollar, after having depreciated by 15 percent in 48 hours. On that day, notwithstanding having just turned the tender age of 35, I also felt old and tired, having been fighting a battle for almost a year to defend our currency in the foreign exchange market but finding the situation getting increasingly out of hand and did not have the time, and the courage, to stock up toilet paper or rice. I did not even have much cash for fear that going to a bank or even using an ATM would trigger a bank run.

Indeed, apart from helping to fight the difficult battle on the currency front, as part of the then Monetary Affairs Branch of the Hong Kong Government, I was also busy helping to nurse, again without much success, a bank that was failing. There had been a run on that bank, albeit a quiet run, with depositors withdrawing money through writing cheques and bank creditors withdrawing interbank lines, rather than highly emotional queues outside its branches. And what had started as a liquidity problem eventually turned into a problem of solvency, as the price of property, in particular commercial property, upon which a large part of the loans of the bank were secured, fell sharply over the uncertainty of Hong Kong's political future, at the height of the Sino-British negotiation.

And so we had to deal with a currency crisis and a banking crisis all at the same time, and the problems had to be resolved almost immediately. The then Financial Secretary, the late Sir John Bremridge, was brought back from Washington D.C. where he had been, ironically, also attending the annual meetings of the IMF and the World Bank. I am sure you are aware of the rest of the story. The Hong Kong dollar's link with the US dollar at the fixed rate of HK$7.80/US$1 was subsequently established and that bank, the Hang Lung Bank, was acquired by Government by emergency legislation and through the use of our reserves - the Exchange Fund. The bank has since been successfully rehabilitated and returned to the private sector.

Ladies and gentlemen, I draw your attention to this contrast of events, occurring on the same memorable day of 23 September fourteen years apart, to impress upon you that Hong Kong's monetary affairs have come a long way. Being the only serving public officer who has been directly and continuously involved in these affairs throughout, I can assure you that it has been most exciting and rewarding to be part of this long march. Looking back, one can notice three distinctive phases in this long march.

Fire Fighting

Margaret Thatcher started it all. She went to Beijing in the fall of 1982, believe it or not, also on 23 September, to start talks on the future of Hong Kong. I joined the then Monetary Affairs Branch of Government as a Principal Assistant Secretary for Monetary Affairs at around the same time and was immediately engaged in fire fighting which lasted for five years in total.

This first phase of the long march of five years from 1983 to 1987 saw a currency crisis at the beginning of the period, the rescue of a total of seven locally incorporated banks over the period and the stock market crash at the end of that period, necessitating the rescue of the Futures Exchange. The cost of all this to Hong Kong in terms of the damage to confidence and reputation was unquantifiable. In terms of dollars and cents, the currency crisis was in fact not a costly one. Net total sales of US dollars through intervention in 1983 to support the exchange rate amounted to US$719 million. As a large proportion of this was at rates above HK$7.80/US$1, it was even profitable in accounting terms.

The bank rescues were, however, costly, totalling in accounting terms HK$3.8 billion. But it was money that had to be spent, for the possible implications of failures on the banking system, and therefore on the currency, were considered unacceptable. Fortunately, the severity of the banking problems lessened over the period as interest rates fell and as confidence on financial markets returned after the signing of the Joint Declaration. From having to acquire the first three of the problem banks, which was costly, guarantees were given to third parties for rescuing the next two, which were somewhat less costly, and temporary interest bearing loans were extended to the buyers of the last two to tie them over, which cost us nothing other than our sweat, for fear that it might not in the end work out. Loans were also extended, through the famous lifeboat facility, to the Hong Kong Futures Guarantee Corporation Limited to enable the Futures Exchange to reopen. Thankfully, all loans had been fully repaid with interest.

Fire Prevention

There was much soul searching during the five years of fire fighting and there was much determination as soon as possible to put our own house in order on the monetary and banking fronts. A start had already been made to overhaul the banking supervisory system with the enactment of a new Banking Ordinance in 1986. This provided a legal framework in which to build a modern and prudent system capable of safeguarding the interests of depositors and the integrity of Hong Kong as an international banking centre - a framework which also retained the much valued Hong Kong tradition of supervisory involvement in business only where necessary and in a non-intrusive manner. That system took shape two years later in 1988 when capital adequacy requirements were formally introduced in Hong Kong. This was ahead of the Basle Capital Accord and the introduction of similar requirements in a number of developed banking centres.

And so that was the beginning of the second five-year period from 1988 to 1992 of putting together fire prevention measures. On the banking front, there was continuous upgrading of the supervisory system in line with the rapid development of banking business, characterized by the globalization of financial markets and the proliferation of financial instruments, but the inability of bank managements to appreciate fully the risks associated with all this and manage them accordingly. Thankfully with the banking problems of the mid eighties fresh in our minds and through sheer hard work on the part of the then Office of the Commissioner of Banking, working in partnership with the banking community of Hong Kong, our supervisory framework and our banking system were strengthened considerably. In each of the five years in this period there was a Bill introduced into the Legislative Council to amend the Banking Ordinance, after full consultation with the banking community and close scrutiny by the Legislative Council.

But no supervisory system or fire prevention measures can be 100 percent fool-proof, particularly when in globalized financial markets it would be almost impossible to immunize an international banking centre like Hong Kong from events outside Hong Kong and beyond our control. And fire did break out again. The collapse of BCCI worldwide and our closure of its Hong Kong subsidiary BCC(HK) in 1991 dealt us another blow. But with the benefit of hindsight the event was more a vindication of the efforts made in strengthening our supervisory system than any indication of continued weakness. Depositors have so far got at least 97 percent of their money back in liquidation (small depositors got back 100 percent), whilst those of BCCI the parent bank only recently received payouts of a small part of their money.

And the contagion effect of that fire, which manifested itself in a run on deposits of several banks, was effectively contained. Something did get burnt, however, and quite publicly, and these were the effigies of four public officers, including myself then as Director of the Office of the Exchange Fund who held the view that another bank rescue through the use of reserves was not justified. Also included, rather unfairly, was David Carse, who had taken up as Commissioner of Banking only the week before the closure and now my very able deputy responsible for banking matters in the HKMA. But the baptism of fire only strengthened our resolve.

On the monetary front, the five years of putting together fire prevention measures were also rather fruitful. The first move was made in 1988, when rather inconspicuously we implemented the so-called Accounting Arrangements between the Hongkongbank, as Management Bank of the Clearing House of the Hong Kong Association of Banks, and the Exchange Fund. Those rather technical but simple arrangements had enormous significance for our monetary system. They effectively transferred the control over the supply and the price of money properly into the hands of government. Not that we wished to control the money supply - that would not be proper operating with a fixed exchange rate - but there was a clear need for tightening the system to ensure that the supply and the price of money, that is, the spectrum of interest rates, behave in the way they were supposed to behave under our linked exchange rate system.

We also brought a monetary policy instrument to the market in 1990, in the form of the Exchange Fund Bills programme, thus further strengthening our monetary armoury. This helped the development of the Hong Kong dollar debt market as we also took the opportunity to establish a computerized, paperless system for registering and clearing debt securities also for the private sector. In 1992 we introduced the Liquidity Adjustment Facility, our version of a discount window to facilitate monetary management by ourselves and liquidity management by the banks.

I cannot be precise as to the extent to which these measures have contributed to monetary stability of Hong Kong. I would like to think that they have been instrumental, for there has not been a lack of events that might have caused serious disruptions to our monetary system, and more specifically to our currency, over that five year period and beyond. There were the events at Tiananmen Square in June 1989, the Gulf War in 1990, BCCI and the bank runs in 1991, the ERM crisis in 1992 and more recently the ups and downs in Sino-British relationship over Hong Kong, the Mexican crisis, sporadic failures of financial institutions in other centres arising from involvement in derivatives, etc. But our exchange rate link with the US dollar remained rock solid and confidence in the Hong Kong dollar remained strong.

And there were other monetary reform measures implemented beyond that five year period, as this clearly should be a continuous process given that the flow of money is never stagnant. These included the establishment of the HKMA in 1993, interest rate liberalization, bilateral repurchase agreements with other central banks to enhance liquidity of our foreign reserves, the introduction of Real Time Gross Settlement to our interbank payment system which has been successfully implemented just three days ago and the scheduled formation of a mortgage corporation next year. All reforms were based on sound justification and introduced with the full support of the financial community.

Promotion and Development

But since 1993 and with the coming into being of the HKMA, we were able again to shift our emphasis. We were beginning to devote relatively greater attention to developing and promoting Hong Kong as an international financial centre. The Sino-British Joint Declaration specified that the Hong Kong Special Administrative Region shall retain the status of an international financial centre. The Basic Law also specified that the Government of the Hong Kong Special Administrative Region shall provide an appropriate economic and legal environment for the maintenance of the status of Hong Kong as an international financial centre. These are clear responsibilities and we take them seriously. Indeed we would be failing in our duties and possibly risk contravening the Basic Law after 1997 if we did not pay adequate attention to this important aspect of our work. So we moved into our third "five-year plan" on monetary affairs in Hong Kong - five years from 1993 to 1997 to put Hong Kong firmly and permanently on the map as an international financial centre of repute.

Although the five-year period is not over yet, for those of you who follow closely monetary affairs in Hong Kong, you will have noticed the increasing involvement of the HKMA, since its establishment in 1993, in international financial affairs. With the strong support of the central banking fraternity, the HKMA became a member of a number of central banking fora, including more recently the Bank for International Settlements; and a worthwhile member too, with significant contribution to promoting international monetary cooperation. Such cooperation is considered essential but somewhat lacking, particularly in this region where the effectiveness of financial intermediation in channelling substantial savings to satisfy the huge investment needs for development is not as high as it should be and where financial liberalization has led to considerable volatility in capital flows which have adverse implications for the stability of monetary systems and financial markets.

The aims of cooperation, particularly amongst central banks in the region should be, on the one hand, to strengthen their defensive mechanisms against financial shocks when they occur; and, on the other hand, to put in place preventive measures to ensure long term financial stability. There are many technical issues involved in both areas, and no shortage of ideas as well as progress. The bilateral repurchase agreements amongst central banks in the region, initiated by the HKMA after the Mexcian crisis in early 1995, were aimed at enhancing liquidity of foreign reserves in the region to tackle volatility of capital flows should they, in the opinion of individual central banks, threaten stability of their individual currencies.

The HKMA has also put forward the more general idea of the formation of an Asian Monetary Network whereby, more specifically, such financial infrastructures as payment systems and debt clearing systems could similarly be linked up on a bilateral basis to facilitate cross currency financial intermediation and the management of risks arising therefrom. There are many other ideas currently being pursued, quite energetically by central banks in the region, and the HKMA is taking an active part, if not a leading role, in all this. And one would expect the monetary authority of an international financial centre to play such a role. The community of Hong Kong expects no less from us.

It is, of course, for others to judge whether Hong Kong is now firmly on the map as an international financial centre. I think it is, but we are not complacent, and this will continue to receive considerable attention from the HKMA in the years to come. In this work I am also sure that we will continue to receive the full support of our future sovereign authority as well as our present one. The word "international" in the term "international financial centre" may carry the implication of the involvement of foreign affairs in which Hong Kong, now and after 1997, does not enjoy total autonomy. But the necessary support is there and has been encouragingly forthcoming.

The HKMA is there, for example, as a member of the BIS along with the People's Bank of China. The same is the case for other central banking fora in which both are involved. The monetary relation between the Mainland and Hong Kong has further been defined clearly as a mutually independent one. And this is not just from me or Governor Dai Xianglong or Deputy Governor Chen Yuan of the PBOC. Vice Premier Zhu Rongji told a delegation of the Hong Kong Association of Banks led by me to Beijing last month that he "agreed with every sentence" of what Deputy Governor Chen Yuan and I had said in the seminar organized at the Bank of England and hosted by Eddie George, the Governor of the Bank on 10 September this year. I therefore recommend that you read those speeches, if you are interested in Hong Kong's monetary arrangements through 1997.

And come that important day of 23 September 1997, the financial world, led by the great majority of finance ministers and central bank governors, shall be here to attend the annual meetings of the IMF and the World Bank. They will witness that Hong Kong, and particularly Hong Kong's monetary affairs, have come a long way from that same day of 23 September fourteen years ago in 1983. They will hopefully give the verdict that Hong Kong is firmly and permanently on the map as an international financial centre of repute, thus concluding for us the successful implementation of our third "five-year plan".

Technological Innovation

What next? It seems that a fourth "five-year plan" would be appropriate. But I must emphasize that, notwithstanding my frequent use of the term "five-year plan" here, I do not actually have much faith in economic planning in the traditional sense. I much prefer the free market approach, with the HKMA there in the background providing the necessary support where the free market cannot be expected to provide the best solution in the overall interest of Hong Kong. A good example is the building of the market infrastructure, which is akin in philosophy to the building of such essential elements as an airport or a tunnel in our physical infrastructure. And as always we will work closely in consultation and in partnership with the financial community.

What every one of us is likely to face in the years to come is the strong challenge arising from telecommunications and computer technology rapidly taking a strong hold of this world. Very soon, we will all be able to communicate with others anywhere in this world by a simple touch of a button that we wear, kind of like what Captain Kirk or Captain Picard have in Star Trek, although I do not yet foresee ourselves being able to be beamed to, say, New York just like that. We are seeing the possibility of more and more business, particularly financial business, being conducted through cyberspace. We are seeing signs of internet banking developing rapidly. There is also the possibility of electronic money becoming popular. So the nature of money is changing, the way payments are made is changing and the relationship between the customer and the bank is changing. The theme of our fourth "five-year plan" would appropriately be "financial technology", specifically how we as an international financial centre should position ourselves to cope with the current wave of technological innovation.

We in the HKMA have been devoting increasing time for strategic thinking on this subject. On the banking side, there are many issues to address. With telephone banking and home banking by the use of computer technology, customers can interact with banks now without seeing anybody or visiting any branch. If this goes on, do we need bank branches anymore? Further, the global nature of the internet is such that banks situated abroad, or indeed virtual banks which exist only in cyberspace, may set up websites which can be accessed by customers worldwide. Amongst other things, such banks may use this as a means of soliciting deposits from customers in Hong Kong. Do they then contravene our Banking Ordinance? Does this amount to the issue of an advertisement in Hong Kong containing an invitation to members of the public to make deposits? If so, then it may be in breach of section 92 of the Banking Ordinance. But it is the customer who is accessing to the bank in cyberspace and not the other way round. What then can we as banking supervisors do to provide protection to Hong Kong depositors? And is our licensing policy for banks appropriate under these circumstances?

On the monetary side, there are equally interesting issues. Electronic money may catch on. Who should issue and are issuers in a position to cope with the associated risks? Are users adequately protected? We have already introduced a Bill into the Legislative Council to lay down a framework for regulation that addresses these issues in a manner that does not stifle technological progress. But I am sure there will be many other issues, as these schemes of electronic money develop along with new technology. What is the likely impact of such a development on the safety and integrity of our payment system and our currency? How would that affect the conduct of monetary policy, particularly in the context of Hong Kong? Banknotes are an important element of Hong Kong's monetary policy. By requiring that they be 100 percent backed by US dollars at a fixed exchange rate, this currency board arrangement provides a firm anchor for our currency. What if banknotes are significantly, or worse still predominantly, replaced by electronic money not subject to the same requirement for foreign exchange backing? To what extent will this undermine the effectiveness of monetary policy?

And more generally on the continued development of Hong Kong as an international financial centre, are we making adequate use of new financial technology to enhance our competitiveness? Costs have been rising due to higher wages and rents, and we obviously need to look to increases in productivity to remain competitive. Are we doing enough here, both in the private and public sectors? In particular, is our financial infrastructure which is so crucial to the conduct of financial businesses playing its role effectively? Does our financial infrastructure contain bottlenecks and barriers that slow down and add costs to financial transactions? Are we, for example, doing enough to facilitate straight through processing (STP) in financial businesses?

Ladies and gentlemen, I am afraid I am only raising these questions today and not answering them. But I am confident that, in due course, we will be able to provide answers in the best interest of Hong Kong, having regard always to our three objectives of maintaining currency stability, ensuring the safety and stability of the banking system, and promoting the efficiency, integrity and development of the financial system. "In due course", according to the established culture of the HKMA, means "by yesterday". So, also in conclusion, let me give you the assurance that we will continue to approach our tasks with enthusiasm, and a clear sense of purpose and vision, as in the past.

We are open and transparent in our actions. We have the support of the financial community with whom we will continue to work in partnership. We have the support of the international financial community, including the central banking fraternity, from where we have free access to experience and advice. We have the support of the Administration, in particular the Financial Secretary, who have entrusted these responsibilities to us, and given us the necessary independence and resources to perform and deliver. We have the support of our present and future sovereign powers in granting us the autonomy that befits our status as the monetary authority of a major international financial centre. I hope we have your support too, as one of the most important chambers of commerce in Hong Kong. Thank you for listening to me.

Last revision date: 1 August 2011
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