The relationship between the Mainland's and Hong Kong's financial markets


28 Jun 2007

The relationship between the Mainland's and Hong Kong's financial markets

The financial systems of Hong Kong and the Mainland should work together for the benefit of the country.

In a market economy, there is usually a high degree of dependence on the market to allocate scarce resources, to bring forth supply where there is unsatisfied demand, to find the right balance between supply and demand, to discover the market clearing price, and so on. The market is usually quite dependable in performing these tasks efficiently in a free environment without the involvement of the authorities in regulating market activities or supervising the behaviour of market participants. But where market freedom risks leading to market distortions, either on the supply side or on the demand side, that are not in the public interest, regulation and supervision are justified. It is never easy to strike the right balance between promoting market freedom and safeguarding the public interest, where there is perceived to be conflict. Indeed public opinion on this issue is never stable, swayed understandably by events that are considered anomalous, often risking over-reaction and therefore erosion of market freedom.

Hong Kong has consistently been named the freest economy in the world. It is an icon of market freedom. But, of course, that status does not imply the absence of market intervention, in the form of regulation or supervision, or indeed the involvement of the authorities in the provision of certain goods and services. The financial markets are a good example, where a measure of protection for investors and depositors is considered essential, as in all other jurisdictions, particularly those housing international financial centres. Even there, much variation exists, at least in the weight of the "supervisory touch", although supervisory standards have become increasingly harmonised in markets that have become global.

It is interesting, particularly from the perspective of Hong Kong, to observe the process by which the functioning of the Mainland economy is moving towards greater dependence on the market. The obvious dilemma that efficient markets and bureaucrats do not co-exist well is not easily resolved. It takes a lot of political skill and courage to promote the sentiment of leaving things to the market and trusting it to do a better job. But we are seeing impressive progress, although from a free-market perspective the pace of liberalisation is never quite fast enough. We see, for example, the gradual liberalisation in the determination of interest rates, although on this front it may still be some time before we see complete liberalisation of deposit and lending rates through the removal of the ceiling and floor currently determined by the People's Bank of China. But it took Hong Kong almost ten years to get rid of the Interest Rate Rules of the Hong Kong Association of Banks. Time and patience are needed to allow the commercial banks to practise conducting business predominantly on the basis of commercial considerations.

One fascinating area is the development of the capital market on the Mainland. To achieve greater financial efficiency and stability, there is an obvious need for diversified channels of financial intermediation. The capital market provides an alternative to the banking channel for financial intermediation, the two channels having significantly different risk-return profiles that are attractive to those who have money to save. While the capital market, as an essential element of modern financial systems, is something that many take for granted, readers should recall that it is very much a feature of capitalism. For it to even exist in a socialist economy, let alone play an important role in financial intermediation, is history in the making; so is the creation of the socialist-market economic model of development. We should therefore not be too surprised to see the authorities being involved in many aspects of the market that would be left to the market elsewhere. Also, it is probably inevitable for the authorities to play a bigger role in development and regulation in an emerging market than would be the case in a developed and mature market.

But this does not necessarily mean that these markets are run less efficiently than they would otherwise be. For one thing, the role of the authorities partly reflects the conditions of the economy that such markets serve, such as the ownership structure and the stage of development noted above. Also, whether in an emerging or developed market, there are always potential conflicts between private and public interests that may affect the functioning of the market. Frankly, there are examples of markets, even in developed capital markets in capitalist economies, being run more in the interest of the financial intermediaries running them than in the public interest of efficient financial intermediation. In general, the authorities face a difficult task of striking a balance between allowing maximum market freedom and preventing public interest being affected by market distortions. Regrettably, however, whether it is in the socialist-market economy of the Mainland or the capitalist free-market economy of Hong Kong, in the public sector or in the private sector, I sense a risk of inadequate appreciation of the wider public interest by those involved in the financial system, in whatever capacity. In the financial area, the public interest of course lies in the efficiency of financial intermediation and the stability of the financial system of the whole country. To achieve this, we should guard against a situation where the two financial systems of our country might adopt too competitive a stance towards each other. The financial systems of the Mainland and Hong Kong should work to further develop a mutually-assisting, complementary and inter-active relationship, as the Premier urged in the National Finance Working Meeting earlier this year.

Joseph Yam
28 June 2007

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