Furthermore, when stable exchange rates are replaced by flexible, volatile and, in all likelihood, depreciating ones, the demand for hedging in the more volatile environment and under liberalized arrangements may drive exchange rates to such debilitating levels that many would regret the lack of resolve in pursuing sensible policies and in the defence of stable exchange rates in the first place. There is no doubt that confidence in the stability of a few Asian currencies has now been badly undermined and rebuilding it may take more than just time. Nevertheless, as the very productive Asian economies find their feet again, they will soon be on their way with renewed vigour. 23. For Hong Kong, as very much a service-oriented economy, any erosion of competitiveness, as a result of our currency holding stable against the US dollar while others have fallen, is likely to be mild. Our economy is not particularly sensitive to exchange rate changes. The IMF forecast for Hong Kong’s growth rate next year is 4.25%, only a shade below our trend growth rate of 5%, representing a healthy consolidation in the circumstances. BIS Review 115/1997
But even if we accept that little can be done to avoid economic cycles, this should not be an excuse for us, central bankers and supervisors. Our responsibility is to develop macro-prudential approaches and the appropriate regulatory measures to help banks reduce the impact of future economic cycles and diminish their procyclical behaviour. This should be achieved for the sake of financial stability with the minimum economic and social costs, which is the main objective of supervisory authorities In fact, banking behaviour can be not only cyclical but procyclical, that is, it can exacerbate the cyclical behaviour of the real economy. As it has been said many times, there is nothing more procyclical than a badly managed bank. In good times it incurs in more risks than it reasonably should through, for example, excessive lending with poor standards. In bad times it changes its lending policies reducing drastically the loans to the economy and exacerbating the downturn. There are several causes that explain this procyclical behaviour but I will focus on the one that affects us most and towards which all of our work should be devoted: banking regulation and supervision. Basel II was seen as a major step towards a better alignment between credit risk incurred by banks and regulatory minimum capital requirements. This link between risk and capital has forced supervisors to better understand the main drivers behind credit risk and the idiosyncrasy of banks’ credit models, their risk pricing and general portfolio management.