This requires financial institutions to internalize the costs of their risk-taking activities up front and to hold capital and liquidity buffers sufficient to handle a plausible range of adverse outcomes. Finally, on occasions when these buffers prove inadequate and a financial firm does reach the brink of failure, the official sector needs the capacity to smoothly wind down such firms so that future taxpayer-funded rescues prove unnecessary. Regulatory and supervisory efforts to accomplish these goals are proceeding down several distinct but related paths:   Increase the capital and liquidity standards for all internationally active banks, measured by both quantity and quality of capital and liquidity, so that they are better able to absorb financial shocks without disrupting the flow of credit to the real economy.   Introduce a credible resolution mechanism for managing the failure of a large systemic bank or nonbank financial institution, to reduce the economywide costs of such failures and, by making them less disruptive, further reduce moral hazard by diminishing expectations of future public support.   Ensure that the largest and most interconnected financial institutions – whether or not they are chartered as banks – face even more stringent prudential standards, in order to reduce moral hazard for the largest firms and lower the probability of their failure to below that of smaller and less systemically important institutions.   Strengthen financial market infrastructures so that when failures inevitability occur, the shocks generated by these failures are dampened, not amplified as they propagate through the financial system.
A further consequence is disruption to the flow of money from savings to investment and disruption to the economic activities that are so important to the well being of our community. By contrast, we saw in the case of LTCM how, in well developed financial markets, financial flows can be effectively redirected to the banking and equity sectors in response to the failure of the debt market. Indeed, the banks themselves were called upon to rescue LTCM and ensure that, even with dislocation in the debt market caused by excessive leveraging, the financial system could continue to function. No matter whether we are responsible for the plumbing of the financial system or for making money work for the community, we in the financial community all have an interest in ensuring that money flows through these three channels freely, safely and efficiently. One important task for all of us has always been to develop a liquid debt market for Hong Kong. As you are aware, the Exchange Fund debt programme, which started in March 1990, is part of that effort, although the development of the debt market was not the only objective of the programme. Since then, we have brought to the market a total supply of paper amounting to about $ billion, with maturities ranging from three months to ten years. We have also developed a robust infrastructure for the debt market that is fully integrated with the real time payment system to achieve real time “Delivery versus payment” in the trading of Exchange Fund paper.