Well-planned, pre-emptive reforms are often more effective than reforms introduced in the heat of a crisis.
Financial reform, whether of the financial system or the regulatory framework, is often introduced as a result of financial crises. This certainly is the experience of many jurisdictions and is understandable given the general tendency of the stakeholders in the financial system to maintain the status quo and protect their own interests. Only when there is a crisis, in which the interests of the stakeholders are thrown badly off balance and pain is inflicted generally or on particular sectors of the community, are structural problems revealed and the authorities forced to embark on reform.
While this is the norm, there are exceptions. In fact, there have been many specific financial reforms in Hong Kong that are exceptions to this rule. Because they were not introduced in a crisis, where there is very sharp focus on the issues involved, they tended not to attract as much attention or be as much appreciated as the crisis-induced reforms. And it is always difficult to assess what would have happened had preventive as opposed to remedial measures not been introduced. But this is not a reason for only introducing financial reform when there is a financial crisis, nor does it mean that crisis-induced reforms are necessarily more important.
Over my years of involvement (since 1982) in the monetary and financial systems of Hong Kong, I have had the privilege of taking part in or steering what can be described as an unusually high frequency of financial reforms. Some indeed were crisis-induced, notably the series of banking reforms introduced as a result of the banking crisis of the 1980s and the seven measures to strengthen the monetary system as a result of the Asian financial crisis of 1997-98. Interestingly, however, there were more financial reforms introduced in the absence of financial crises: the acquisition of control over that crucial element of the Monetary Base now called the Aggregate Balance in 1988; the creation of an effective monetary-policy tool with the introduction of the Exchange Fund Bills and Notes programme in the early 1990s; the introduction of a macro-prudential approach to banking supervision in the 1990s; limiting contagion through the interbank market by introducing the Real Time Gross Settlement (RTGS) interbank payment system in 1996; the assumption of more direct control over the Monetary Base at the same time; the introduction of the strong-side Convertibility Undertaking and the Convertibility Zone, to make the control over the Monetary Base more rule-based and transparent, strengthening the monetary system ahead of the introduction of exchange-rate flexibility in the renminbi in 2005. There were also the contingency plans worked out, quite meticulously, in peaceful times for implementation at the inevitable times of crisis to limit damage – for example, the temporary liquidity arrangements, the Contingent Bank Capital Facility and the 100% deposit guarantee introduced in the current global financial crisis.
Personally I prefer pre-emptive or preventive financial reforms to remedial ones. But obviously nobody can foresee all of the weaknesses in the financial system, whether or not they are of structural significance. The very high financial rewards of financial innovation make it difficult for regulators to stay ahead of everything. We cannot expect to get it right all of the time, but we try to do so as often as possible. In this, although I probably have some personal bias, I think that the HKMA has a better batting average than most. The fact that our monetary and financial systems have held up well and remained robust against the worst financial crisis for many years is evidence of this. Of course, this does not mean that we can relax in performing our duties. We remain alert, particularly during stressful times, and we always strive to do our best.
At a time when the authorities facing crisis, particularly those in Europe and America, are talking about financial reform, the correct approach for Hong Kong is to keep a close watch, rather than jumping onto any bandwagons. The current global financial crisis has highlighted the drawbacks of many models of financial regulation and the robustness of our own. Now is not the time to emulate others blindly.
Joseph Yam
25 June 2009
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