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SCMP Reporter

WHILE the Monetary Authority is celebrating the 10th anniversary of the linked exchange rate system, it is also busy negotiating with the note-issuing banks to tackle a sticky side-issue of the peg.

  The note-issuing banks are confronted with the unpleasant decision of whether they should shoulder all the exchange gains and losses arising from fluctuations in the exchange rate in the market.

  If the answer is yes, the much-criticised bank charges on bulk cash deposits will be lifted; note-issuing banks will no longer face losses on bank note arbitrage; and the Government will not be questioned by Legislative Councillors on why it is punishingcustomers for putting money into the banks.

  However, the decision is not a simple yes or no. It relates to how the note-issuers perceive the strength of the Hong Kong dollar against the US dollar in the coming years - a question of confidence.

  The problem surfaced two years ago amid outcry from customers who are charged by banks upon depositing large amounts of cash.

   The charge was disguised as a type of handling charge and disgruntled customers have been forced to accept the explanation that free banking services are a thing of the past.

  However, as Monetary Authority chief executive Joseph Yam commented: ''From the point of view of the proper conduct of the business of banking, such a charge is obviously undesirable.''   The origin of the problem dates back to the bad old days of 1983 when the peg was created in an atmosphere of fear and panic.

   Capital flight and the weak Hong Kong dollar drove the note-issuers to adopt a pass-on arrangement.

  Since they were then bound by the rule that bank notes were issued and redeemed by the Exchange Fund at a fixed rate of 7.80 to one US dollar, the chances were high that they would have to acquire US dollars in the foreign exchange market at a more expensive rate to meet demand from other banks and their own customers.

  So they decided that the risk should be shared among all banks. By adopting the pass-on arrangement, all non-note-issuing banks have to come up with US dollars at the 7.80 rate should they wish to draw bank notes.

  In recent years when the market rate has deviated a great deal from the 7.80 level, net takers of bank notes from non-bank customers have faced an exchange loss.

   ''This is because when surplus bank notes are returned to the note issuers, they can only get a US dollar value at 7.80, whereas the market exchange rate is at a stronger level,'' Mr Yam said.

  Having discussed the issue with banks involved, the authority came up with a suggestion to terminate the pass-on arrangement, and ''bank notes would be supplied against clearing balances of banks for Hong Kong dollar value'', he said.

  The proposal is based on two major considerations - leaving the existing exchange rate system intact and obviating the unpleasant charges that antagonise both commercial banks and their customers.

  Under the proposal, the possible losers will be the note-issuers.

   ''They alone would clearly stand to benefit from the ever increasing amount of bank notes in circulation when the exchange rate is on the stronger side; but they would also stand to lose should the exchange rate move to the weaker side,'' Mr Yam said.

  However, he is convinced that the chance of loss is much smaller than the possibility of achieving an exchange gain.

   ''Look at Asia's economic growth and Hong Kong's important position in this market. I can't see any reason why we should worry that the Hong Kong dollar will be weak against the US dollar in the coming years,'' he said.

  ''With an above 10 per cent increase in new notes in circulation every year, the note-issuing banks will be able to make a substantial gain when the exchange rate is strong,'' he said.

  He argued that when the exchange rate was weak, it would be in everyone's interest to strengthen it again.

   ''There are ways to achieve this, such as increasing the interest rate and reducing the supply of new bank notes,'' he said, adding that the loss to note-issuers would then be minimised.

  With the termination of the pass-on arrangement, the incentive for bank-note arbitrage will be removed.

  This leads to concern that without arbitrage, which is believed to act as a mechanism to correct wide deviations, the link may be weakened.

  Mr Yam disputed that idea. ''Its real significance depends on the actual as against the psychological role that this type of arbitrage has played in ensuring exchange rate stability,'' he said.

  The proposal has been sent to the two note-issuing bank and the Bank of China, which next year will become the third note-issuer.

   ''The ball is in their court,'' Mr Yam said.

  Both Hongkong Bank and Standard Chartered Bank are studying the proposal.

   ''We have to assess the chances of the exchange rate remaining persistently weak and vice versa, and its impact on the banks,'' said G.C. Goh, area head of treasury at Standard Chartered.

       He expected a decision to be made shortly.



Authority tackles peg poser