Previously only HK$100,000 per depositor was protected under a bank-funded scheme, an amount considered inadequate amid growing jitters about the stability of lenders. Bank of East Asia suffered a run on its branches last month as the global financial storm strengthened.

Under the measures announced yesterday, the government will use the Exchange Fund - the reserve backing the city's currency - to guarantee HK$6 trillion in deposits.

The government will also set up a special fund from which the 23 locally incorporated licensed banks can access additional capital if necessary.

Both measures take immediate effect and will remain in force until the end of 2010.

'These are precautionary measures. We do not expect that it will need to be triggered, as our banking system is robust,' Financial Secretary John Tsang Chun-wah said.

Hong Kong joins Australia and New Zealand in extending deposit protection amid the worst financial crisis in decades. Macau's government also announced yesterday that it would fully guarantee the deposits of all 28 local banks, amounting to about 228.4 billion patacas.

Hong Kong Monetary Authority chief executive Joseph Yam Chi-kwong said the fact other governments had already given similar blanket guarantees to depositors had created a risk of capital flight from Hong Kong - meaning depositors moving their assets from the city's banks to those in countries where all deposits are safe.

Mr Tsang said members of the Exchange Fund Advisory Committee had agreed unanimously to introduce the measures to enhance confidence in Hong Kong' financial system and safeguard the interests of depositors.

Mr Yam said the government would provide funding to banks on a case-by-case basis and did not rule out buying preference shares.

The protection applies to all Hong Kong dollar and foreign currency deposits held in authorised institutions, including branches of overseas institutions. These deposits total about HK$6 trillion.

However, the assets of the Exchange Fund stood at HK$1.4 trillion at the end of August, meaning that in the worst case it would not be sufficient to cover all deposits.

Mr Yam said the probability of a bank collapse was relatively low, given the strength of the city's financial system.

'I expect we won't need to use a penny from the Exchange Fund,' he said.

The average capital adequacy ratio of Hong Kong banks was 14 per cent, well above the 8 per cent international standard, Mr Yam said.

He admitted there could be a moral hazard in providing full deposit protection - meaning banks' risky practices would be rewarded - which was why the measure would initially last only to the end of 2010.

Billy Mak Sui-choi, associate professor of finance and decision science at Baptist University, said: 'The measures will help stabilise the markets and restore confidence to some extent.'

Parties across the political spectrum agreed the measures would boost confidence and provide much-needed insurance. Still, their suddenness took some by surprise.

'Joseph Yam just said at Legco yesterday that the crisis would not have an excessive impact on Hong Kong and that the banks could take it, but then they introduce this measure,' said Civic Party legislator Ronny Tong Ka-wah.

A crisis of confidence in banking systems worldwide has sown panic among stock market investors. More than US$6 trillion was wiped off the value of shares in major markets last week alone. But government steps to bolster banks have reassured them.

The Hang Seng Index has rebounded 13.76 per cent in two days. The Dow Jones rose a record 11.08 per cent on Monday. European markets made big gains. Japan's Nikkei index rose a record 14.15 per cent yesterday.

Additional reporting by Nick Westra