The best example of what the Hong Kong Monetary Authority (HKMA) is trying to achieve with its package of reform measures is the change to a discount window from the previous liquidity adjustment facility (LAF).
The LAF, which was introduced in 1992, was always criticised in some circles because, by classic currency-board rules, it appeared like tinkering with the system where tinkering is not allowed.
The classic rules say that a currency board issues HK dollars when it receives US dollars in exchange for them at HK$7.80 to US$1. When people want US dollars back, the board takes their HK dollars at that same exchange rate, then puts them out of circulation. This is all that a classic currency board is supposed to do.
It works because if no one wants HK dollars and they are exchanged in large quantities for US dollars, then soon there will be a shortage of HK dollars in the system as they are taken out of circulation.
Those people who then still need HK dollars will be forced to bid up interest rates to get them. Sooner or later the interest rates will go so high that the rewards of holding HK dollars will appear attractive again and the money will flow back.
In this scheme, the LAF superficially looked like a dodge to evade that temporary pain of high interest rates on which the system depends. It allowed banks to borrow money from the HKMA rather than bidding up interest rates in the market.
But the LAF was set up because there are simply times when banks run a little short of ready short-term funds for reasons that have nothing to do with whether people generally want HK dollars or not. Why cause interest rates to go up as if in a panic when there is no panic? Here is the crux of the matter, however. The HKMA was never required to make the LAF available to every bank that wanted to use it, and, back in October last year, it came to the view that some bankers were using the LAF to speculate against the currency.