Similarly, the Term Securities Lending Facility (TSLF)—which involved the swap of Treasury collateral from the Federal Reserve against lower-quality collateral held by primary dealers—was introduced in large part because collateral swaps, unlike cash loans, did not affect the amount of reserves in the banking system. My overall point is that broad-based, open-ended lender-of-lastresort facilities are more difficult to accommodate in a corridor system because of the need to drain any reserve additions to keep the federal funds rate close to the FOMC’s target. I see this as an important shortcoming of the pre-crisis corridor regime that does not get sufficient attention. Having the ability to introduce broad and credible lender-of-last-resort backstops—well secured by pledged collateral—can be critical when confidence falters and financial stability is at risk. Private sector participants are more likely to continue to engage with their counterparties—and to borrow and lend—when they know a central bank backstop will be available if economic and financial conditions deteriorate. A corridor regime could cause the Federal Reserve to delay or avoid providing such backstops, which could increase financial stability risks by causing lenders and borrowers to disengage with one another earlier.12 Although the FOMC has not made a final decision about a future framework for implementing monetary policy, meeting minutes confirm that participants recognize the advantages of a floor system. As the November 2016 FOMC minutes note: “Meeting participants commented on the advantages of using an approach to policy implementation in which active management of the supply of reserves would not be required….

Government influence also directed bank lending into uneconomic projects and non-viable companies. This government involvement lent credence to the view that regional banks were effectively government guaranteed, which made it easier for these banks to borrow in the global interbank market. This provided the fuel for the irresponsible lending which took place. Hong Kong did not suffer from these structural and systemic weaknesses. But it is the case that imbalances had emerged in the economy, and this became particularly evident during 1997 as confidence grew that the Handover would proceed smoothly - as indeed it did. This was reflected in soaring residential property prices - up by an average of 48% during the year to October 1997 and a record level for the Hang Seng Index of 16,820 in August 1997. The boom in asset values was to a large extent financed by the banks. The sharp escalation in asset prices and in bank lending was clearly unsustainable. A downward adjustment would have been necessary and would have happened sooner or later. All that was required was an external shock to bring it about. This of course is precisely what happened in BIS Review 48/1998  -2-  the third week of October when the Hong Kong dollar came under speculative attack. The operation of our currency board system meant that the sales of the Hong Kong dollar depleted the clearing balances which the banks maintain with the HKMA for settlement purposes and the resultant shortage of liquidity caused interest rates to rise sharply.