, which is equally, if not more, controversial. i am referring to the proposal to introduce a deposit insurance scheme ( “ dis ” ) in hong kong. in a sense, this can be seen as the other side of the coin to deregulation. increased competition in a deregulated environment may give rise to increased risk and therefore it seems right that we should look again at the arrangements for dealing with banking failure, should it occur. let me hasten to add that we have no reason to believe that such a failure will occur. the banking system in hong kong remains profitable and robust, despite the challenges that it faces. our system of banking supervision is also generally reckoned to be effective. but banks can still get into difficulties because of risks that supervision may not be able eliminate. there is always the possibility of external shocks or unfounded rumours that may damage confidence in a bank. deposit insurance, like other forms of insurance, is there to deal with low probability events that have a major impact if they occur. to make an obvious analogy, you still take out fire insurance even if you do not expect your house to burn down. hong kong stands out as one of the few developed banking centres which does not have a dis. there is of course no reason why we should follow the rest of the world just for the sake of it. but we should at least keep our safety net arrangements under regular review to ensure that they are still appropriate to changing market circumstances. this is what we did last year when we engaged an external consultant to consider whether the existing deposit protection arrangements in hong kong were sufficient, and if not how they should be changed. the conclusion was that an explicit and limited form of deposit insurance should be introduced. we subsequently undertook a public consultation on this proposition and on the detailed design features of the proposed scheme. this consultation generated a heated, albeit civilised, debate. not surprisingly, some of the large banks vehemently opposed the scheme. opinion in the community as a whole was however generally supportive. in particular, the legislative council passed a motion by a wide margin urging the government “ expeditiously to implement a dis, which is cost effective and easy for depositors to understand, for effectively protecting small depositors, and to formulate appropriate complementary measures aimed at reducing the risk of moral hazard. ” the hkma has studied the responses received during the consultation and has submitted a report to the government on the outcome. we are seeking a decision in

principle on whether we should proceed with the deregulation, subject to further work on the technical arrangements during the rest of this year. i cannot anticipate what the decision of the government will be nor can i provide details of what the final shape of any scheme would be. i will however comment on two key issues. the first is that even the supporters of deposit insurance, including legco, are keenly aware of the need to minimise moral hazard. moral hazard refers to the incentive for increased risk - taking that may be created by deposit insurance. the problem is that both banks and their depositors may exercise less self - responsibility if they know that deposits are protected. this is a risk in any form of insurance, but it has received particular attention in relation to deposit insurance because of its alleged role in the savings and loan crisis in the united states in the 1980s. moral hazard is a real issue, but it is one that can be addressed. the first essential is that the design features of the dis itself should provide incentives for risk - minimising behaviour by market participants. this means in particular avoiding over - generous protection and limiting the scope of the dis strictly to the protection of small depositors. there was general agreement in the public consultation that coverage in the dis should be kept relatively low, in the range of hk $ 100, 000 to hk $ 200, 000. it appears that the lower end of this range would probably be acceptable. the second element in reducing moral hazard is to maintain effective supervision to curb excessive risk - taking by banks. in this connection, we are presently in the process of enhancing our supervisory system to make it more risk - focussed. the final safeguard derives from the market discipline exercised by those stakeholders in a bank – the uninsured depositors, bank creditors and shareholders – who are exposed to the risk of loss if a bank fails. such persons have a vested interest in monitoring the behaviour of banks and in sending the appropriate market signals, in the form of withdrawal or higher cost of funds, or lower share price, to banks that are taking too much risk. to do this, of course, the market needs sufficient information about the financial position and performance of banks. increased financial disclosure is something that the hkma has been encouraging over the last few years. the other main issue to emerge from the consultation is that of cost. the large banks in particular are concerned that they will end up paying for the bulk of the cost of a