FINANCIAL AND MONETARY AFFAIRS
The supervisory approach of the HKMA is based on a policy of 'continuous supervision'. This involves the on-going monitoring of authorised institutions using a wide variety of techniques which are aimed at detecting any problems at an early stage. Consolidated supervision is exercised by the HKMA on a global basis over institutions which are incorporated in Hong Kong.
Prudential supervision in Hong Kong is carried out mainly through on-site examinations, off-site reviews and prudential meetings. On-site examinations provide the HKMA with the opportunity to assess at first hand how an institution is managed and controlled. They are particularly useful for assessing asset quality and the adequacy of internal controls. Off-site reviews involve the analysis of regular statistical returns, and accounting and other management information supplied by institutions, with a view to assessing their performance and compliance with the Banking Ordinance. They are followed by prudential interviews with the senior management of the institutions, at which the business, prospects and potential areas of concern of institutions are discussed. This approach enhances the HKMA's ability to identify potential areas of concern, which can be followed up by on-site examinations.
As an international financial centre, Hong Kong follows banking supervisory policies that are in line with international standards, especially those recommended by the Basle Committee on Banking Supervision. The Basle Committee issued proposals for the supervision of market risks in 1995. Market risk is defined as the risk of loss in on- and off-balance sheet transactions arising from movements in market prices. It covers transactions relating to foreign exchange, interest rates, equities and commodities.
The HKMA is considering how and when a market risk supervisory framework should be implemented in Hong Kong. The local framework will be based on the Basle proposals but will take into account the generally low level of exposure to market risks of local authorised institutions. The latter has been confirmed in a survey on market risk based on the Basle framework conducted by the HKMA in April/May 1996. To start the implementation of the local market risk supervisory regime, locally incorporated institutions have been required to report to the HKMA on a regular basis their market risk exposures since the end of 1996. The Basle Committee continues to develop an agreed common framework for measuring interest rate risk by international supervisors. The HKMA will continue to monitor developments on this issue.
In view of the fast-growing derivatives market, the HKMA strengthened its supervisory efforts in this area. Since 1995, it has conducted a survey of risk management practices of derivatives participants, conducted a series of treasury visits to authorised institutions on derivatives activities and strengthened the staff resources of a specialist team with the recruitment of additional expertise on derivatives products and financial models.
The HKMA also required all authorised institutions which engage in the trading of derivatives to perform a review of their internal controls and to report their findings to the authority subsequent to the Baring's crisis. Where weaknesses have been identified, the HKMA has asked institutions concerned to take immediate action to eliminate them. Further to a guideline issued to authorised institutions on risk management for derivatives in 1994, the HKMA issued in March 1996 an operational
73