The repayment guarantee of all deposits in Hong Kong is a temporary measure applied at a delicate time when confidence in the banking system is threatened by the worst global financial crisis in a century, Monetary Authority Chief Executive Joseph Yam says.

In his weekly Viewpoint column published today, Mr Yam said this type of blanket guarantee for depositors may, however, introduce distortions to the banking system and additional supervisory attention will be needed.

"For example, it may affect the incentives for prudent management of risks by banks, the competitive environment among banks and the need for depositors to exercise due diligence. This in turn may lead to considerable moral hazard," he said, adding the local banking system is robust with very good asset quality and the probability of a bank failure in Hong Kong is very low.

The aggregate classified-loan ratio of retail banks is at a very low level of less than 1%, as compared with over 10% in September 1999 and 2.5% before the Asian financial crisis.

The aggregate capital adequacy ratio and liquidity ratio of locally incorporated banks, currently at around 14% and over 40%, are also way above the statutory minimum of 8% and 25%.

In the unlikely event there is a bank failure in Hong Kong for whatever reason, the probability the bank will be insolvent - the assets of the bank on liquidation will be inadequate to cover its liabilities - is also low.

"This means if the Government guarantees the repayment of all deposits in Hong Kong in the event of a bank failure through the use of the Exchange Fund, the contingent liability for the Fund, in the form of the shortfall, if any, of assets over deposit liabilities of the failed bank, would be small," Mr Yam said.