Time will provide an opportunity for deeper reflection, and it is important that careful thought does come before action. But I would identify three lessons. First, liquidity should be central to the regulation of banks. Regulation worldwide has paid insufficient attention to liquidity, focussing instead on capital. Northern Rock did not face a problem of inadequate capital. But it was vulnerable to a shock that reduced the liquidity in markets for securitised mortgages. Banks need to face the right incentives to manage their funding positions. Smaller banks with reliance on wholesale funding should be encouraged to put in place insurance. We should not, however, expect regulation alone to solve this problem. That is why I think it is so important to create the right incentives. Second, the single largest impediment to dealing with Northern Rock was the absence of a mechanism for intervening pre-emptively in a bank in trouble to separate the retail deposit book – the insured deposits – from the rest of the bank’s balance sheet. The ability to do this is central to the way the US and other systems operate, where the authorities are obliged to step in early – “prompt corrective action” – to protect depositors. One tool at their disposal, currently unavailable in the UK, is a special insolvency law for banks. Legislation to create the powers to deal with a bank in this way seems to me the single most important necessary reform. Deposit insurance is another area that requires change.
Nevertheless, there is much that the government can do to facilitate financial-market development by clearing the way, particularly where this involves markets of a regional nature. Three areas of work in which the HKMA – with various partners – is taking an active role are worth citing here. The first involves the gradual introduction and expansion of renminbi business within Hong Kong, which requires primarily co-operation between the Mainland and Hong Kong authorities at various levels, including both political and technical. The second example is our collaboration with other central banks in the region, under the auspices of EMEAP, on the Asian Bond Fund, which is intended not just to encourage business in the debt market, but also to stimulate regulatory reforms in economies in the region. The third example is our work in encouraging the development of Islamic finance in Hong Kong, through ensuring a level playing field, stimulating interest in Hong Kong among Islamic countries, encouraging product development, and raising market awareness within Hong Kong, particularly through the educational work of the Treasury Markets Association. All of this work looks both to the past and to the future for inspiration. Looking to the past, we have the still-recent experience of the Asian financial crisis, one element of which was the undeveloped state of some of our financial markets, in particular the debt market. Many of the market-development initiatives on which we have been working have been intended to address these deficiencies.