mr. carse speaks on banking supervision in hong kong and the lessons learned from the financial crisis in asia speech by the deputy chief executive of the hong kong monetary authority, mr. david carse, at the asian investment conference “ asia : meeting the challenge ” held in hong kong on 27 / 3 / 98. 1. i am pleased to be here this morning to speak to you on the topic of the supervisory lessons which hong kong can learn from the region and specifically from the crisis which has engulfed asia since july of last year. this is a drama that is still being played out and we have not yet reached the final act. but i do not think that it is too early to make some kind of judgment about what went wrong and the lessons that can be drawn for the future. the asian crisis 2. i think that it is fair to say that the asian crisis has surprised almost everyone by its speed and intensity and the ease with which it spread from country to country. even those who were sceptical about the asian miracle did not really expect anything like this. of course, there were warning signs such as the current account deficits in a number of countries such as thailand. but these could be regarded as the natural consequence of the heavy demand for investment in growing economies. the asian economies were certainly not fault - free, but in general they not exhibit the classic signs of gross macroeconomic weakness that normally lead to a balance of payments crisis. governments ran fairly prudent fiscal policies, savings were high and inflation rates reasonably low. even if policy mistakes were made, the punishment does not really seem to fit the crime. 3. why then have exchange rates fallen by as much as they have and why have economies in the region been so severely crippled? it is generally agreed that a large part of the answer lies in the weakness of financial and banking systems in the region, which have amplified the initial effects of external shocks and economic downturn. in essence, banking systems that were already in weak health before the crisis broke were not up to the task of intermediating large inflows of capital. they have been part of a vicious circle whereby loss of confidence in the currency leads to loss of confidence in the banking system that further undermines the currency. this is the “ run on the country ” syndrome. it therefore follows that strengthening of the banking system must be part of the cure of the asian disease and the means of preventing a recurrence. banking supervision has an important part

result in excessively high real interest rates, a price stability - oriented monetary policy will actually lead to lower real interest rates by reducing inflation risk premia, thereby promoting growth and employment. by credibly pursuing price stability, monetary policy also directly contributes to the stabilisation of short - term fluctuations in output and employment. in a monetary policy regime with a clear focus on price stability, inflation expectations are firmly anchored such that increases in inflation are not expected to be long - lasting. as a result, adverse supply shocks, such as an increase in oil prices, have less effect on inflation and unemployment and, at the same time, monetary policy has more leeway to accommodate such shocks. in this context, it is important to note that the ecb pursues its price stability mandate on the basis of a monetary policy strategy with a strong forward - looking element. the ecb ’ s strategy comprises a definition of price stability as an annual increase in the hicp of below but close to 2 % over the medium term and a broad - based analysis of the risks to price stability in the context of our two - pillar framework. our definition of price stability implies that we do not attempt to fine - tune the inflation rate at very short horizons, but aim at keeping inflation below but close to 2 % over the medium term. this medium - term orientation of our strategy has given us the flexibility to respond firmly, and yet with a forward - looking approach, to the series of adverse economic disturbances that have hit the euro area over the last nine years. the firm focus on price stability has ensured that expectations have remained stable even in the face of protracted inflationary shocks, while the forward - looking approach has made it possible to achieve this objective without unnecessary fluctuations in real activity. and yet, despite the fact that our monetary policy strategy evidently works very well, revisions to our strategy are advocated from time to time. for example, it is sometimes proposed that we should abandon our two - pillar framework for the analysis of risks to price stability and instead adopt a full inflation targeting approach. another proposal that is sometimes made is that we should have our inflation goal or a new inflation target endorsed by the eurogroup. i disapprove of these proposals. first, having our inflation goal endorsed by the eurogroup would require the ecb and the eurogroup to reach a consensus in this regard, which would not be compatible with our independence in the pursuit of our mandate to maintain price stability. second, the proposal