The Bottom Line:
In this insight, Antoine Martin analyses the recent release of the Hong Kong Monetary Authority’s (HKMA) Revised Guideline on Authorization of Virtual Banks. Hong Kong is one of the world’s leading financial places, yet the city’s banking offer is limited for many. This move by the HKMA creates a significant new potential from a financial services perspective, but there is more.
With the Revised Guideline on Authorization of Virtual Banks, the HKMA has several objectives in mind. First, opening access to financial services to non-banks. Second, solving a market deficiency which so far has left many citizens un-banked. Third, pushing Hong Kong’s Fintech policy a little further. Keep reading for more.
Analysis | Virtual banks regulation in Hong Kong: HKMA pushing into smart banking and Fintech
[ By Antoine Martin]
In May 2018 following a public consultation on the development of virtual banks in Hong Kong, the Hong Kong Monetary Authority (HKMA) released its Revised Guideline on Authorization of Virtual Banks. The Guideline is nothing new, it should be noted, as its first draft originates from 2000. Still, the move by the Monetary Authority has attracted comments and expectations from Hong Kong’s financial industry.
This insight explores the whys and hows of Hong Kong’s move towards virtual banking. At the end of the day, indeed, the Revised Virtual Banks Guideline has several interesting objectives.
One objective, obviously, is to create a friendly framework to further develop Hong Kong’s financial industry. Another objective for the HKMA is to correct a concerning and handicapping deficiency in Hong Kong’s banking market, i.e. under-banking. The third objective is rather strategic: boosting Hong Kong’s efforts towards becoming the Fintech hub in the Asia-Pacific region.
Building a framework for the regulation of Virtual Banks
The first objective of the Revised Virtual Banks Guideline is to build a framework to further develop Hong Kong’s financial industry.
The idea of a framework for virtual banks is not new in Hong Kong. As already noted, the HKMA has only ‘revised’ a document originally created eighteen years ago – without impact. In 2000, the Hong Kong Monetary Authority declared that it was not opposed to the development of virtual banking. Nowadays, the approach is now very different. Hong Kong not only “welcomes” virtual banks. It needs to create a friendly environment to foster their development.
There is an important industry development objective here. In fact, the first selection criteria provided by the Revised Guideline – before financial requirements – is very clear. Every virtual bank application “must have substance and cannot simply be a ‘concept'”. Hence, “taking advantage of the popularity of new technology” will not suffice. The applicant must have a “concrete”, “credible and viable” business plan. And such a business plan must “which strike an appropriate balance between the desire to build market share and the need to earn a reasonable return on assets and equity”.
— Virtual banks as real banks bound by the current banking framework
The HKMA does not only focus on industry development, however. The HKMA’s key objective is to ensure that virtual banks will be real banks bound by the current banking framework.
Indeed, the supervision of future virtual banks will not differ from the one imposed on brick-and-mortar players. The Revised Guideline admits that “some […] requirements will be adapted to suit the business models of virtual banks”, and the necessity to manage physical branches will for instance be reduced to an obligation to hold a physical office in Hong Kong.
Otherwise, the Revised Guideline on Authorization of Virtual Banks is very clear. Forthcoming virtual banks “will be subject to the same set of supervisory requirements applicable to conventional banks”. The new players will be expected to “attach equal importance to the management of credit, liquidity and interest rate risks”. They will be bound by ownership, capital adequacy, risk management and financial reporting requirements as currently applicable. Their parent companies – banks or not – will need to support the newly created virtual banks as much as necessary. And they will have to provide the HKMA with an exit plan… capable of preventing negative effects on consumers and on Hong Kong’s financial system should rewinding proceedings be necessary.
— HKMA virtual banks Guideline opening banking to non-bankers
Having said this, another key idea of the Revised Virtual Banks Guideline is that virtual banking opens to non-bankers. As formulated in the document, “both financial firms (including existing banks in Hong Kong) and non-financial firms (including technology companies) may apply to own and operate a virtual bank in Hong Kong”.
There is another interesting point to note. When delimitating its scope of application, the Revised Guideline defines virtual banks as banks “which primarily deliver retail banking services through the internet or other forms of electronic channels instead of physical branches”.
In doing so, the HKMA is therefore making two significant moves.
First, it takes a clear market-opening and market-diversification stand. By allowing non-banks to apply for virtual banking licenses, the HKMA opens banking to investors vested in customer service. And, in doing so, it also opens the door to new forms of financial innovation based on new economic models.
Second, in focusing on retail, the HKMA attempts to correct a major deficiency in Hong Kong’s banking market.
Virtual banks to correct a deficiency in Hong Kong’s banking market
The HKMA is well aware of a major deficiency in Hong Kong’s banking market.
Hong Kong might be one of the leading financial cities in the world but its inhabitant lack adequate banking services.
First, Hong Kong is known for the difficulties many businesses encounter when it comes to opening a basic bank account. Second, part of the population is also under-banked and ill-equipped from a personal finance perspective. Hence, the opening of a virtual banking industry aims at providing solutions to a problem that brick-and-mortar banks have failed to solve.
In fact, the financial inclusion aspect of the forthcoming virtual banking framework is a clear objective by the Monetary Authority. “[L]ike conventional retail banks, virtual banks should play an active role in promoting financial inclusion in delivering their banking services”, says the guideline. Moreover , Deputy Chief Executive of the HKMA Arthur Yuen was quoted as follows in the South China Morning Post:
“We expect virtual banks will focus on retail and SME businesses, but we will not require what type of services they must offer to customers. They could choose their business scope, ranging from payments, deposits and loans, to wealth management and other lending”.
— Virtual banks are a promising market.
Virtual banks are a promising market but so far it is impossible to say how many applications will be submitted. There are clues, however.
The Financial Times reported in early June that the Standard Chartered bank planned to apply. Other sources mention other names, such as ITF (a US bank). Neat (a Hong Kong-based financial services provider) would also be part of the first batch of applicants. And so would WeLab (another Hong Kong-based financial entity with strong ties in Mainland China).
But there will be more. From a regulatory perspective, the license granted to virtual banks will be the same as the one granted to normal brick-and-mortar financial institutions. As a result, virtual bank license holders will have access to tremendous cash flows (deposits, loans, etc.) even if they are not banks originally.
A major consequence of this barrier-breaking move will most likely be an enormous demand from non-bank financial actors from Mainland China.
In contrast with Mainland China, the offer for virtual financial services in Hong Kong is low. Here, physical branches remain the norm. There, fully digital financial services and Stored Valued Facilities (SVF) systems are already replacing traditional banking. In other words, Hong Kong and its eight million inhabitants now represent a major market for financial services providers. And they will seek to invest… without dealing with capital-demanding physical branches.
— HKMA’s Revised Virtual Banks Guideline welcomed warmly by Hong Kong’s financial sector.
Without surprise, the Hong Kong’s financial sector sees the HKMA’s Revised Virtual Banks Guideline as a positive development.
The Consultation’s feedback was described as being constructive and positive by the HKMA, but some public comments have also been made by leading voices. A comment by KPMG noted that “The HKMA’s proposal is a timely update to the original guidelines for virtual banks” and “the […] proposed revisions […] are to be applauded. Alternatively, the Hong Kong Fintech Association welcomed “the emergence of ecosystem driven business models […] likely to become a differentiating factor for global FinTech hubs”.
Comments are difficult to find at this stage. Nonetheless, two of the likely applicants have explained why the Revised Virtual Banks Guideline would be economically impacting.
Simon Loong, Founder of the Hong Kong and Mainland China-based online money lenders WeLab said:
“Getting a virtual banking license from the HKMA would allow us to expand our services. This would allow WeLab to diversify its business to become a full services bank […] Developing virtual banking in Hong Kong would also allow the city to catch up with international markets as many US and European markets already have pure online banking operators.” (Source: SCMP)
Similarly, David Rosa – Co-Founder of the Neat Fintech – explained that the change in framework would allow challenging the current banking monopolies by allowing new players to receive deposits while offering loans and permitting cross-border transfer services (Source: Ejinsights).
— Fears: will virtual banks evolve in a leveled playing field?
Supportive comments rarely come alone, there are various fears. Acting as a promoter of financial innovation, the Hong Kong Fintech Association was on the front scene.
The idea that virtual banks will have no possibility to impose minimum balance requirements on their clients raises concerns. As a reminder, normal brick-and-mortar banks do not face similar requirements. Hence, for the Hong Kong Fintech Association, “the revised guideline is unclear as to whether it is placing a specific financial inclusion requirement on virtual banks in a manner which is not expected of existing conventional banks”. The HKMA, nonetheless, maintains that financial inclusion is the driver behind the new virtual banking policy.
Capital requirements (HK$300 million – about US$38.36 million) also raise concern as to the viability of the virtual banking market. By imposing such a threshold, indeed, the HKMA might actually limit the entry of non-brick-and-mortar players on the market. In other words, the Monetary Authority is taking the risk to make virtual banking purely a “Big Boys’ game” (Source: Ejinsights).
Beyond capital constraints, the Revised Virtual Banks Guideline has a financial stability component. It makes clear that there will be no room for aggressive market-building strategies. This could possibly restrain the strengths of the most disruptive non-bank candidates. To the HKMA the restriction is a matter of sound economic governance, however, as suggested by the Revised Guideline:
19. […] it would be a concern if a virtual bank planned to aggressively build market share at the expense of recording substantial losses in the initial years of operation […]. Predatory tactics could be detrimental to the stability of the banking sector and could undermine the confidence of the general public in the bank itself.
- The Asia-Pacific Circle -
The virtual bank policy as a strategic move for Hong Kong’s Fintech profile?
The third objective of the Revised Virtual Banks Guideline is very strategic. Beyond the opportunity to develop its banking sector and to increase financial inclusion, the HKMA pushes its Fintech agenda. In short, it shows that the Government’s project to turn Hong Kong into Asia’s first Fintech hub is progressing.
— Surfing on the Fintech trend?
At the time of the first Virtual Banks Guideline, in 2000, the idea of doing banking without banks was innovative. Yet, the technology and the market were simply insufficient. The idea was there, for sure, but virtual banking was not a reality.
Since then, however, technology has evolved drastically and online banking has become a habit. People use all sorts of apps on a daily basis to transfer money both locally and internationally. In Mainland China most payments now work through Stored Valued Facilities (SVF) such as We-Chat. Elsewhere, fully virtual banks are already very common. In short? Hong Kong is lagging behind.
— A regional fintech hub policy move
The Revised Virtual Banks Guideline therefore has a third major objective: fulfilling Hong Kong’s Fintech agenda.
The Asia-Pacific Circle published a research report several months ago to analyze and decode a white paper on The Future of Hong Kong’s Fintech by the Hong Kong Financial Services Development Council (FSDC). Many people took one idea from this document, i.e. that Hong Kong was good at fin but bad at tech. The analysis we made, however, was that the white paper was rather a business plan, a roadmap designed to help turn the city into the region’s leading Fintech Hub. Quite a difference.
Surprisingly, the term “virtual banks” didn’t appear at all in the FSDC white paper. Nonetheless, the HKMA’s virtual banks initiative goes in the same direction.
Over the past years, the Hong Kong Budget Speeches have systematically talked about setting up a robust Fintech policy… which some skeptics still question, as a matter of fact. In September 2017, a keynote speech by the HKMA’s Chief Executive furthermore “unveiled a number of initiatives that prepare Hong Kong to move into a New Era of Smart Banking”.
Amongst the key ambitions of that new era of smart banking, these were the main ideas. A faster payment system and an enhanced fintech Sandbox supervision system. Virtual banking and easy banking. Not to forget open APIs and closer cross-border collaboration aimed at further developing Hong Kong’s Fintech profile. Promising!
— A logical move
In short, the virtual banking move of the HKMA does not only make sense, it is logical. Hong Kong does not merely surf on the Fintech wave here, it tries to push it further.
Think about it. A key idea of the Future of Fintech white paper was that Hong Kong should become a leader in cybersecurity. What could be better than developing a virtual banking and smart banking economy? Quite an opportunity to invest in risk management expertise and cybersecurity, isn’t it?
Fintech competition in the Asia-Pacific region
Until then, Hong Kong has a lot of catch-up work to do. If only because many virtual banking initiatives are already taking place in the Asia-Pacific region.
J.P.Morgan already has several virtual branches in mainland China to answer increasing digital transformations in the local banking industry. And the bank also develops in India, Indonesia, and Thailand. Similarly, Citibank testing a system in over sixteen countries, while Standard Charter’s LiveBank virtual banking system is also being developed in nine countries (source). An interesting article by FintechNews furthermore suggests that purely virtual banks – described as Neo Banks – are already operating in India (Digibank), Vietnam (Timo), Japan (Jibun Bank) or Korea (K Bank and Kakao Bank). Hong Kong is definitely lagging behind.
Interestingly, while Hong Kong’s main competitor on the Fintech scene is Singapore (of course), a gap is missing. The two cities seem to be at the same can-do-better level on the virtual banking side of things. When asked whether any plans existed to give online banking licences to internet companies focused on providing solutions for mobile payments, the public authorities answered that the existing licencing framework could well “accommodate internet-only banks” which would then “operate within the same licensing and regulatory regime as conventional banks” and would thus require license in order to take deposits and grant loans. So far, nonetheless, FintechNews notes that as far as Singapore is concerned, “a challenger bank for Singapore is still missing”.
The Revised Digital Banks Guideline is undeniably a welcomed initiative in Hong Kong.
Nothing suggests that virtual banks will revolutionize the markets. In fact, the fear so far is that the virtual banking market might mainly be accessible to the largest players. Nonetheless, the financial industry sees the move as an opportunity to develop new services. By the same token, the HKMA might correct market failures created by recent developments in global financial regulation.
On paper, this could become a win-win situation. Until then, however, Hong Kong has work to do. Especially if it intends to take the lead in virtual banking in the Asia-Pacific region. Before getting into a hasty conclusion, therefore, let’s see how things take place. Applicants have until August 31st to make a move.
Dr Antoine Martin | Co-Founder & Head of Insights
Dr Antoine Martin is the Head of Insights of The Asia-Pacific Circle, which he co-founded in Hong Kong in 2016. Antoine follows analyzes and comments on developments in international trade, investment, and finance, with a particular focus on Asia-Pacific relations. He is also a scholar at The Chinese University of Hong Kong, Faculty of Law, a leading academic institution in Asia.
Disclaimer: The views expressed in the insights are those of their author(s) only and should not be considered as reflecting those of The Asia-Pacific Circle or of its editors.
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