risks and systemic risks all have to be managed, both at the micro level and at the macro level. all markets suffer from the “ fallacy of composition ”. mistakes at the corporate or bank level will add up to national mistakes, which now may add up to regional or international crisis through contagion. traditional risk management at corporate or sectoral level simply shift risks from one sector to another. risks still remain in the economy as a whole. thus, increasingly in the 1980s, there emerged the awareness that financial sector regulation was all about national risk management. 21. national risk management covers six major aspects : • credible policies, with monetary and fiscal policies consistent with each other, and applied consistently. • capital account liberalization should be phased appropriately. • sound fundamentals include a high domestic savings rate, sustainable fiscal and balance of payments positions, high foreign exchange reserves and prudent debt management. • good supervision involves the maintenance of solid capital adequacy and liquidity requirements for the financial sector, as well as regular examination and monitoring of financial institutions and markets. the banking system must have the capacity to avoid excessive credit concentrations and risks, and to manage market risks well. • a robust financial infrastructure would encompass an efficient payments and settlements system for domestic and international transactions. in essence, the world is moving towards real time gross settlement ( rtgs ) system, which support delivery vs. payment ( dvp ) and payment vs. payment ( pvp ). rtgs reduces payment risks and allows central banks to monitor flows in domestic currency as well as exposure of banks on a real time basis. • a non - distortive incentive structure, such as taxation or regulatory restrictions that would not encourage risk concentrations or excessive leverage in any economic sectors. 22. put simply, managing national risks is equivalent to achieving three objectives. first, lower national gearing, because leveraging adds risks, especially if this is leveraged from external borrowing. the more you borrow abroad, the more you become vulnerable to external shocks. second, the higher the level of domestic savings, which should be reflected in higher bank capital, lower credit / gdp ratio, and higher fiscal surpluses, the greater the resilience to the pain of adjustment to external or internal shocks. third, irrespective of the exchange rate regime, there must be a commitment to a stable currency, and this means strong external reserves, low inflation and a sound banking system. asset prices and the exchange rate regime 23. the

benefited directly from two of these measures. the first is the granting of easier and greater access to the mainland banking market under cepa from 1 january 2004 and the second is the introduction of personal renminbi business in february. these will in time help to broaden meaningfully, i am sure, the scope of banking business for banks in hong kong. i should add that there are other initiatives being developed, with the aim of positioning the banking system of hong kong to take advantage of further financial liberalisation in the mainland. i hope they can be agreed, announced and introduced soon. short - term risks however, the generally good news in recent months should not blind us to the problems that remain in our economy or to the risks that face us. while the economy has been recovering strongly, it has not been creating as many jobs as we all would like to see. it is also uncertain to what extent the budget deficit will be reduced, as government revenues recover along with the economy. to be sure, the difficult investment environment is not helping us in our attempt to meet the budgeted investment income for the fiscal reserves. disappointments on these fronts may affect market sentiment in the short term, although the determination and ability on the part hksar government in tackling the remaining, structural components of these problems should not be in doubt. furthermore, there is a risk that our financial markets could over - react to external developments, notably stronger than expected monetary tightening in the us, macro - economic adjustments in the mainland and sharp increases in oil prices. although it is unlikely that these external factors would derail our economy, and so this risk seems small, under extreme market conditions, short - term volatility in financial markets could have a bearing on monetary and financial stability in hong kong. in contrast, there are also concerns about the effects of continuing easy monetary conditions within hong kong. during the past few months, economic recovery has resulted in inflows of funds into the hong kong dollar to the extent that the aggregate balance of the banking system has become extraordinarily high ( despite some outflows recently associated with the corrections in the financial markets ). as you know, under the currency board system there is not much that we can do to dampen easy monetary conditions : this is a question that the sub - committee on currency board operations of the exchange fund advisory committee has given a great deal of thought to. if there continue to be capital inflows on the back of sustained growth and confidence