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Financial and Monetary Affairs 95

accordance with the Financial Reporting Council Ordinance, pass the results of the probe to the HKICPA or to law enforcement agencies such as the Independent Commission Against Corruption (ICAC), the Police, Department of Justice, or the SFC for follow-up action. This arrangement is provided with proper checks and balances. in respect of the different roles of 'investigator', 'prosecutor' and 'disciplinary committee'. The HKICPA continues to handle cases involving unlisted companies.

Monetary Policy

The main aim of Hong Kong's monetary policy is to maintain currency stability, which is defined as a stable external exchange value of the currency of Hong Kong, in terms of its exchange rate in the foreign exchange market against the US dollar, at around HK$7.80 to US$1. This objective is achieved through a linked exchange rate system introduced in October 1983.

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The linked exchange rate system is characterised by currency board arrangements requiring the Hong Kong dollar monetary base to be at least 100 per cent backed by and changes in it to be 100 per cent matched by corresponding changes in US dollar reserves held in the Exchange Fund at the fixed exchange rate of $7.80 to US$1. In Hong Kong, the monetary base includes the amount of currency notes and coins issued, the Aggregate Balance (the sum of the clearing balances of banks held with the HKMA for the purpose of effecting the clearing and settlement of transactions between banks themselves and also between the HKMA and banks), and the outstanding amount of Exchange Fund Bills and Notes.

Since the inception of the linked exchange rate system in October 1983, note- issuing banks have been required to hold Certificates of Indebtedness (CIs) issued by the Exchange Fund to provide backing for bank note issuance. The issuance and redemption of Cls are made against US dollars at the convertibility rate of $7.80 to US$1 for the account of the Exchange Fund. Similarly, the issue and withdrawal of government-issued currency notes and coins in circulation are conducted against US dollars at the fixed exchange rate of $7.80.

A Liquidity Adjustment Facility was set up in 1992 to enable the HKMA to provide lending to any bank with day-to-day shortages of liquidity. This was replaced in September 1998 by the Discount Window arrangement under which banks have unrestricted access to day-end liquidity through repurchase agreements using EFBNs as collateral. A two-tier structure of Discount Rates has been adopted to ensure that interest rates are adequately responsive to capital flows, while avoiding excessive interest rate volatility if liquidity shortages are only modest.

Under the currency board system, Hong Kong dollar exchange rate stability is maintained through an interest rate adjustment mechanism. The monetary base increases when the foreign currency (in Hong Kong's case, US dollars) to which the domestic currency is linked, is sold to the currency board for the domestic currency (inflow into the Hong Kong dollar). It contracts when the foreign currency is bought from the currency board (outflow from the Hong Kong dollar). The expansion or contraction in the monetary base leads interest rates for the domestic currency to fall

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