The use of the Exchange Fund to provide full deposit protection may generate moral hazards as it will give incentives for banks to take more risks in order to earn higher profits, industry watchers say. Observers were responding to the Hong Kong government's move to follow Taiwan and countries such as Australia by providing 100 per cent insurance to depositors, lifting the protection coverage from the present limit of HK$100,000. In normal circumstances, a deposit insurance system will not offer full coverage and only part of the losses will be covered by a deposit insurer or other government bodies. However, a government source said central banks had reached a consensus that efforts were needed to shore up financial institutions at this time and concerns over moral hazards had to be put aside temporarily. 'Deposit insurance can be a source of moral hazard in the banking system,' said Billy Mak Sui-choi, associate professor at Baptist University's department of finance and decision science. 'When customer deposits are completely insured, banks will be more inclined to lend to riskier customers since any loss will be covered by the government, and in turn the taxpayers, rather than the banks themselves.' Calls for substantially raising the HK$100,000 cap on bank deposit insurance widened after bank run rumours sparked long queues for cash withdrawals formed outside Bank of East Asia branches last month. Proponents argued that insurance protection only gave guarantees in the event of a bank's collapse and hence there was no incentive to take on excessive risks. 'Banks in Hong Kong are too big to fail. Their risk-taking might not be affected by the full deposit insurance protection,' said Law Ka-chung, chief economist and strategist with the Bank of Communications. Joseph Yam Chi-kwong, chief executive of the Monetary Authority, said a comprehensive review of the existing scheme was needed in 2010, when the full deposit insurance protection measure expired. But local lenders were reserved over the need to increase the protection limit and deposit types, as the expansion would put extra cost burdens on them. 'The additional cost will ultimately transfer to customers or shareholders,' said Sandy Flockhart, chief executive of HSBC's Asian operations. The Deposit Protection Scheme Fund, set up in September 2006, had a total of HK$616 million as of March and the target fund size is HK$1.5 billion, according to the Deposit Protection Board's annual report. The fund collects money from the banks ranging from 0.05 per cent to 0.14 per cent of yearly deposits.