Globalisation and the increasing complexity of international fund flows are making it more difficult to maintain monetary and financial stability. This is a task that cannot be achieved in "automatic gear".
From time to time, we hear comments that the HKMA runs in "automatic gear", which always brings a slightly rueful smile to my face. It's true that the Currency Board system is designed to respond automatically to fund flows in and out of Hong Kong and maintain a stable exchange rate between the Hong Kong and US dollars. We have used the term "auto pilot" to explain the working of the system so perhaps it is our own fault if some people in the community think the system just works without any input from us. It is also, in a way, pleasing that people are so comfortable with the monetary and financial stability that the Linked Exchange Rate system provides that they sometimes take it for granted.
I, of course, like to think that it is the way the HKMA has been run in the 13 years of its existence that has given the community this welcome level of confidence in Hong Kong's monetary and financial systems. We will continue to do our best. Thanks to the governance structure of the HKMA I believe we have the flexibility in the deployment of resources necessary to do a good job while remaining accountable to the community for ensuring that we use those resources responsibly.
The confidence of the community in the system does not come easily. Monetary and financial stability are not matters that can be taken for granted, particularly for an economy as free and open, and externally oriented, as Hong Kong. Hong Kong is an international financial centre with large capital flows, generating a volatility that itself attracts enormous amounts of international capital looking for a quick return. The size of the financial markets in Hong Kong - large enough to provide the liquidity that attracts capital but small enough for large fund flows to make waves - is conducive to instability. We at the HKMA put a great deal of effort into anticipating problems and defusing them before a costly financial crisis can occur. We do not hesitate to speak out when we see a need for an alternative view, or when we think that a danger might be overlooked. A recent example of this approach of heading off trouble was in May last year when we introduced the three refinements to the Linked Exchange Rate system. Readers may recall that there had been very large inflows of funds into Hong Kong, partly as a result of speculation that the renminbi would appreciate and the Hong Kong dollar would follow. The excess liquidity brought about by these fund flows suppressed local interbank rates and created a situation that was potentially destabilising. The refinements removed the uncertainty about how far the Hong Kong dollar would be allowed to appreciate and preserved the stability of the system. The Aggregate Balance declined, interest rates returned to more normal levels and the speculative money departed. When the renminbi exchange rate regime was indeed reformed in July, the Hong Kong dollar exchange rate was barely affected.
Nor is the monetary system our only responsibility. In fact, only a quite small percentage of our staff time is devoted to day-to-day operations of the Currency Board. As the banking supervisor, we occasionally exercise our statutory authority and issue guidelines on areas of concern. Sometimes difficult and unpleasant decisions have to be made. We also lead major initiatives that have contributed to strengthening the robustness of our financial systems - deposit protection to strengthen the confidence of depositors; the sharing of credit data to help banks to manage credit risk; payment, clearing and settlement systems to make financial intermediation more efficient and to prevent financial contagion. These systems too are perhaps sometimes taken for granted; it is in the nature of things that people only notice them when they occasionally go wrong.
In fact, there is not much, if anything, in the work of the HKMA that can be done "automatically" to the extent of not requiring the close attention that we have been paying to all of our policy areas. For example, as the banking community will confirm, there is nothing automatic about banking supervision. When the rules now being drafted for implementing Basel II are published, those who have been involved will appreciate the amount of work that has gone into the preparation and how they are consistent with the philosophy of risk-based banking supervision that we have been promoting for many years. Deposit protection is certainly not an automatic outcome, and neither is the sharing of commercial and consumer credit data, which helps keep the non-performing loan ratio of the banking system low and has benefited consumers by allowing them to replace credit card debt with other, cheaper forms of borrowing. The robust and efficient financial infrastructure that Hong Kong enjoys did not automatically come into existence, nor could we leave initiatives to develop it further entirely to the private sector. The 24 basis points by which the Exchange Fund out-performed the return of the benchmark portfolio in 2005 were also not automatic, and those 24 basis points alone are enough to fund the administrative expenditure of the HKMA for three years.
I hope that the comfort people feel about our monetary and financial systems will not obscure the enormous effort that has gone into designing and refining these systems over the years or the great deal of hard work that goes into making sure that they operate safely and efficiently. The staff of the HKMA remains dedicated to this task.
Joseph Yam
20 April 2006
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