Hong Kong

Author: | Published: 9 Jul 2001
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As an international financial centre in China, Hong Kong sports a strong banking and financial system that is continually having to react to changes in mainland China and the Asia Pacific region, as well as globally, at the same time as maintaining an independent banking and financial system under the "one country, two systems" principle. With China on the brink of joining the World Trade Organization (WTO), Hong Kong is poised to take advantage of this development. The effect of China's entry into the WTO is likely to permeate all sectors of Hong Kong's banking community, yet how well the banking community will in fact fare still remains an open issue.

Key regulatory bodies

As Hong Kong's de facto central bank, the Hong Kong Monetary Authority (HKMA) has regulatory and supervisory functions over banks, while Hong Kong's Chief Executive and Financial Secretary have a key role in guiding the fiscal and economic policies of Hong Kong. The Financial Secretary, with assistance from various advisory bodies, oversees the financial and monetary affairs of Hong Kong and works closely with HKMA in maintaining a stable financial environment. The Hong Kong Association of Banks (HKAB), whose membership consists of all licensed banks, is, among other things, responsible for determining bank interest rates, commissions and charges, and is authorized to fix the maximum interest rates payable to bank customers on certain Hong Kong dollar deposits (although its role will be minimized in this respect in July 2001, as discussed below). Additionally, the Securities and Futures Commission in conjunction with HKMA serves to regulate the securities-related activities of banks, while the Stock Exchange of Hong Kong supervises the activities of Hong Kong-listed banking institutions. To the extent the activities of banks involve insurance businesses, these are regulated by the Insurance Authority. Regulatory bodies have generally been kept busy throughout the last 12 months, as Hong Kong attempts to recover from the Asian economic crisis and looks forward to China's WTO accession.

Market trends

Hong Kong has one of the highest concentrations of banking and financial institutions in the world. At the end of 2000 in Hong Kong's three-tier banking system, there were a total of 154 licensed banks, 48 restricted licence banks and 61 deposit-taking companies, while 118 overseas banks had representative offices in Hong Kong.

During 2000, pre-tax operating profits of local banks rose by an aggregate of about 38%, largely as a result of an overall decline of problem loans and consequent bad debt provisions. With increased competition, this year should be a significant year for banking institutions in Hong Kong. As the banking environment becomes more competitive and domestic loan demand has not shown any signs of recovery, banks are increasingly having to find new ways to earn income, with more emphasis placed on diversification of business and development of new financial products and services. With total bank deposits increasing by 9.6% in 2000, banks generally have high liquidity. Although demand for residential mortgage loans is slow as the property market remains soft, increased bank competition has resulted in aggressive price cutting, freebies and lower interest margins, all benefiting the consumer.

2001 is forecast to be a sluggish year for banks with margins being squeezed, profit growth more subdued and lowering bad debt provisions. At the same time, HKMA, among others, is adding new challenges for banks to promote efficiency and the transparency, safety and soundness of the banking system.

As more and more Hong Kong businesses seek to establish or reinforce their links with mainland China in anticipation of WTO entry, so the banking community needs to react effectively to these changes taking place. Many Hong Kong businesses are already inextricably linked with China, and banks will need to react swiftly to changes in their customer profile to stay competitive. Already there is much debate as to how far the business creation effect of WTO entry will outweigh the business diversion effect for the banking community so as to allow Hong Kong's banks sufficient room to take advantage of a surge in banking business in mainland China. The question of asset size is relevant, especially for the smaller banking players, if they are to compete effectively or at all in the China market – this is particularly relevant since mainland China presently has a $20 billion criteria for overseas banks (including Hong Kong banks) setting up branches there. At the same time, even where a boost in bank lending into mainland China is predicted, HKMA remains wary that the business diversion effect of WTO entry needs to be controlled by continual improvements to the infrastructure framework and regulatory regime to maintain Hong Kong as a top-class financial centre.

With a deregulated environment and increased competition among banks, consumers are likely to take on increased risk and the government is considering the implementation of a deposit insurance scheme. As expected, large banks are opposed to the scheme. Other than the cost factor, one criticism of such a scheme is that it encourages banks and depositors to take bigger risks knowing that they are insured. In any event, it is unlikely that such a scheme will be implemented before 2002. At the same time, HKMA is considering the setting up of a commercial credit reference agency to enhance credit risk management and ultimately improve the soundness of Hong Kong's banking system. Such an agency would hopefully lead to finer pricing, enable banks to reduce their reliance on collateral, and perhaps reduce their reluctance to lend to small and medium-sized businesses.

The increasing level of pollution and the fact that green groups are becoming more vocal in Hong Kong have meant that environmental risk management has become a topic with which banks should be concerned. While reminding banks of environmental risks associated with lending and promoting the business opportunities that environmental protection can provide, HKMA has recommended that banks build environmental risk assessments into their credit decisions where appropriate.

The minimum standards set by HKMA for financial disclosure by Hong Kong incorporated banks (save for smaller, restricted licence banks and deposit-taking companies) continue to be elaborated, with the guidelines on this topic published on December 8 2000, which apply to banks' financial year ending on or after December 31 2000. Such banks must include a statement reflecting the status of compliance with such guidelines in their directors' report, and the reasons for any non-compliance.

Banks and their securities businesses

Banks and their subsidiaries that carry on securities businesses and are thus subject to the supervision of the Securities and Futures Commission (SFC) need to follow the Code of Conduct for Persons Registered with the SFC, which has been revised starting April 1 2001 to offer better consumer protection. Such revisions include new risk disclosure statements tailored to different services and products, explanation of terms and relevant risks, and timely and accurate reporting. Even though by being an authorized institution under the Banking Ordinance, banks are granted "exempt dealer" status by the SFC, they are still required by HKMA and SFC to follow the practices set out in the Code of Conduct and other SFC directives, as supplemented from time to time. An instance would be the recent revision by the SFC of the "fit and proper" criteria for bank representatives to undertake securities business to meet new standards of competence.

Under a Banking Amendment Bill that is soon to be enacted, HKMA's supervisory role will be enhanced so as to be able to take reasonable steps to ensure that any banking business, any business of taking deposits, or any other business carried on by a bank under its supervision is carried on with integrity, prudence and the appropriate degree of professional competence, and in a manner that is not detrimental, or likely to be detrimental, to the interests of depositors or potential depositors. The Bill aims at, among other things, more protection for investors, less regulatory overlap and lower regulatory costs.

Once enacted, the legislation would put beyond doubt the powers of HKMA in the supervision of the activities of banks operating securities businesses. The Bill also requires every bank with securities businesses to appoint no less than two executive officers to be directly responsible for supervising the conduct of such businesses.

E-banking business for banks

It was not so long ago that commentators would have readily postulated that the internet would quickly revolutionize banking in Hong Kong. However, to date, while about 20 or so banks have introduced transactional e-banking services for retail customers, and a number of banks have introduced corporate e-banking, the percentage of retail customers using e-banking remains very low, estimated at below 5%. The majority of transactions over the internet tend to be simple enquiries, although stock trading is increasing in activity.

While promoting competition and innovation, and not preventing progress in e-banking, HKMA has set about assisting banks in controlling and minimizing risks. Since 1997, various HKMA guidance notes and circulars have alerted banks to risk management of e-banking, although security and integrity of data, and consumer protection remain major concerns. Specifically, the Guidance Note on Management of Security Risks in Electronic Banking Services (July 6 2000) and the Guidance Note on Independent Assessment of Security Aspects of Transactional E-banking Services (September 26 2000) make it incumbent on banks' senior management to manage the risk of e-banking products and services.

HKMA published a guideline in May 2000 relating to the establishment and operation of virtual banks. Under this guideline, virtual banks will be subject to the same prudential criteria that apply to conventional banks and must have a physical presence in Hong Kong. The virtual bank can be locally or overseas incorporated, but a Hong Kong incorporated virtual bank applicant must either be an existing restricted licence bank or deposit-taking company, or an existing bank that intends to convert its business to virtual banking.

Despite the relatively lukewarm reaction to e-banking, Hong Kong's basic infrastructure for promoting e-commerce is in place – notably the Electronic Transactions Ordinance 2000 granting general legal recognition to electronic records and digital signatures, and recognizing public key infrastructure in which banks should play a major role. However, HKMA continues to recognize the difficulty in regulating overseas institutions that use the internet to attract offshore deposits from Hong Kong residents which, while covered under the regulatory regime in Hong Kong, HKMA finds difficult to enforce.

Consolidation of banks

Mergers and acquisitions appear to be the trend in the rationalization of the banking industry to achieve greater size and economies of scale, and increase the customer base. The consolidation of banking businesses in Hong Kong appears to be gathering pace in line with the trend in many other jurisdictions. For instance, Bank of East Asia bought First Pacific Bank in 2000. This year, Bank of China and Industrial Bank of China are each consolidating their positions in Hong Kong. The 10 member banks of the Bank of China group will, when merged, form a new bank incorporated in Hong Kong that will have two other subsidiary banks, thereby creating the second-largest banking group incorporated in Hong Kong. While the smaller local banks may not be under immediate pressure to consolidate, this is one issue that their management will no doubt scrutinize from time to time.

Corporate governance

In an effort to direct the banking community on the manner in which the business and affairs of banks should be managed by their board of directors and senior management, in May 2000 HKMA released guidelines entitled "Corporate Governance of Locally Incorporated Authorized Institutions", superseding the best practice guide issued in 1991. The necessity for such guidelines has been brought about by deregulation, globalization and liberalization of the financial markets, technological advances, and advances in financial products and services. These guidelines set out minimum standards that HKMA expects a bank to be able to meet. Failure to do so casts a doubt on its ability to comply with the minimum requirements for authorization under the Banking Ordinance. Among the many principles, the guidelines seek to target unsecured lending by banks to connected parties, which is regulated under section 83 of the Banking Ordinance. The guidelines also set out in some depth the responsibilities of a Hong Kong incorporated bank's board of directors to shareholders, depositors, creditors, employees and other stakeholders such as HKMA and other regulatory bodies, and how the management of a bank should manage risk, approve strategies and business plans, conduct operations prudently, and act with a high degree of integrity.

As a process integral to good corporate governance, HKMA has been promoting quantitative impact analysis to assess the degree of impact of the New Capital Accord (comprising the internal ratings-based approach) that is being developed by the Basel Committee on Banking Supervision.

Prevention of money laundering

In December 2000, HKMA issued a Guideline on Prevention of Money Laundering, pursuant to the Banking Ordinance. In the Guideline, HKMA takes on board the basic policies and principles set out in the Statement of Principles issued by the Basel Committee in December 1988. Under the Guideline, banks should "know their customers" and ensure there are effective procedures to obtain satisfactory evidence of the identity of their customers. Corporate accounts are recognized as a key vehicle used for money laundering and specific measures are mentioned in the Guideline to prevent money laundering. A bank should appoint a compliance officer who is responsible for reporting suspicious transactions under current legislation to the Joint Financial Intelligence Unit (operated jointly by the Police and Customs and Excise Department). It is a bank's responsibility to ensure that its employees who are dealing with a customer engaged in money laundering acts report such acts, and it is a criminal offence to fail to report either knowledge or circumstances which give rise to a reasonable belief in the existence of a money laundering act. The Guideline also addresses a bank's need to provide proper anti-money laundering training for its staff, and cites a long list of examples of suspicious transactions.

To further improve the effectiveness of the existing anti-money laundering regime, the government has introduced a bill, aptly entitled the Drug Trafficking and Organized Crimes (Amendment) Bill 2000, to amend two existing anti-money laundering statutes, namely, the Drug Trafficking (Recovery of Proceeds) Ordinance of 1989, providing for the tracing, freezing and confiscation of the proceeds of drug trafficking and creating the offence of money laundering in relation to such proceeds, and the Organized and Serious Crimes Ordinance of 1994, which extends the money laundering offence to cover the proceeds of indictable offences in addition to drug trafficking.

The Amendment Bill is notable in that it gives wider powers to enforcement agencies to trace, restrain and confiscate proceeds derived from drug trafficking or indictable offences. It will allow prosecutors to assume, in the case of a defendant being convicted of a money laundering offence, that all property held by such defendant or which has passed through the defendant's hands in the last six years, will have come from drug trafficking or an indictable offence.

The Amendment Bill will also tighten up on the criminal offences relating to dealing with property known or believed to represent the proceeds of drug trafficking or indictable offences. Specifically, the Amendment Bill proposes the introduction of a new criminal offence of dealing in property. No doubt, if the Amendment Bill is enacted in its present form, banks will need to be more vigilant in detecting and reporting suspicious money laundering transactions to avoid criminal sanctions. It will no longer be necessary for the prosecution to prove that the employees of a bank knew or actually believed or suspected that a money laundering transaction was being committed. Instead, it will be sufficient for prosecutors to show objectively that such employees had reasonable grounds to suspect money laundering. The Amendment Bill's proposed changes have understandably caused serious concerns for banks that, because of their position, are more likely than anyone else to come across money laundering scenarios in their day-to-day operations.

Interest rate deregulation and imposition of bank charges

Business is going to get tougher for banks as interest rates are deregulated. July 2000 saw the deregulation of interest rates covering time deposits with a maturity of less than seven days. The cap on interest rates for savings accounts and the prohibition on the payment of interest on credit balances in current accounts are scheduled for removal on July 3 2001, in the absence of materially adverse circumstances in the meantime. To meet the forthcoming development, some banks have indicated that they will impose new service charges to cover administrative costs. Banks are also expected to tier interest rates to attract more deposits.

In view of the deregulation of the remaining interest rate rules in July 2001, as well as increased pressure on margins consequent upon intense competition between banks, in May 2001 HKMA brought out amendments to Chapter 2 (relating to accounts and loans) of the Code of Banking Practice to deal with the anticipated effects of these developments. The recommendations under the revised Code now seek to incorporate the best practices previously set out in the interest rate rules of the HKAB. It is anticipated that the retention of such rules will minimize the risk of disputes between banks and their customers in the taking of time deposits.

The revised Code pertaining to notice given to customers in respect of altering fees and charges, and the basis of such fees and charges became effective as of June 15 2001, some three weeks before the deregulation of the interest rate rules. Basically banks should provide at least 30 days' prior notice to affected customers of the level or changes in the level of fees and charges. Noteworthy is the commercial likelihood of banks imposing stepped fees and charges, depending on the profitability of customers to the banks and the nature of banking services offered. The revised Code will make it clear that banks should inform customers of the basis, not only upon which interest but also fees and charges, is calculated. This will cater for the situation where banks are increasingly prone to levying a charge on accounts with credit balances not exceeding certain thresholds at any time.

Towards better consumer protection

As of January 15 2001, HKMA revised the Code of Banking Practice applicable to individual customers generally (with few exceptions) to increase banks' accountability to customers. This comes about as a result of the case of Hang Seng Credit Card Limited & Ors v Tsang Nga Lee & Ors in July 2000, which basically ruled that the indemnity costs provision in the credit card agreement between the customer and the credit card issuer was unconscionable. A revised Chapter 3 of the Code now states, among other things, that:

  • affiliated companies controlled by banks will fall within the ambit of the Code;
  • the annualized percentage rates (APRs) for retail purchase and cash advances, together with the annual card fee, should be provided to the customer. Calculation of APRs is to be standardized;
  • the reasonableness and fairness of APRs that exceeds the level which is presumed to be extortionate under the Money Lenders Ordinance (at present 48% pa) should be justified;
  • a cardholder's maximum liability when his or her credit card is lost or stolen should be limited to HK$500 (US$64) unless he or she has acted fraudulently, or has been grossly negligent or otherwise has failed to inform the card issuer as soon as reasonably practicable after having found that his or her credit card had been lost or stolen;
  • card issuers may only recover reasonably incurred costs, and a detailed breakdown of such costs should be given to customers on request; and
  • subsidiary cardholders should not be held liable for the debts of the primary cardholders or other supplementary cardholders. Claims on rights of set-off between their accounts should be advised.

Real-time US dollar clearance

The launch of the US dollar clearing system in Hong Kong in August 2000 marked an important milestone in the development of Hong Kong's clearing and settlement infrastructure. The new system provides financial institutions with an efficient and reliable system for settlement of US dollar transactions on a real-time basis in the Asian zone. It is hoped that this system, the first of its kind in Asia, will help consolidate Hong Kong's financial position in the region.

A number of principal settlement facilities are provided through this system. First, the participating financial institutions may effect interbank US dollar payments on a real-time basis during Hong Kong business hours. The system is linked with both the Hong Kong-listed shares clearing system (CCASS) and debt securities settlement system (CMU). By such linkages, institutions can carry out delivery-versus-payment settlement (DvP) of US dollar-denominated securities or products traded on Hong Kong's stock and futures markets. DvP can significantly reduce the settlement risk previously associated with the trading of US dollar-denominated securities in Hong Kong. Secondly, the system interfaces with the existing Hong Kong dollar clearing system to allow banks to settle Hong Kong dollar/US dollar foreign exchange transactions on a payment-versus-payment basis (PvP). With the PvP facility, settlement risk arising out of two legs of Hong Kong dollar/US dollar foreign exchange transactions having to be settled in different time zones can be eliminated. Thirdly, the US dollar clearing system comes with a local US dollar cheque clearing mechanism. This allows banks in Hong Kong to render local US dollar cheque account services to their customers, who can now enjoy greater convenience in making US dollar payments in Hong Kong. The local US dollar cheques can now be cleared through this US dollar clearing system, instead of having to be sent back to New York for processing. Thus the settlement time for US dollar payments can be shortened significantly.

Financial restructurings and insolvencies

While financial restructuring of Hong Kong businesses are being completed, and the number of new financial restructurings continues to diminish as the economy picks up, there still remains a need for banks to deal with bad or problem debts to meet HKMA requirements. It is probably correct to say that, like it or not, banks in Hong Kong have accumulated substantial knowledge of insolvency techniques and financial restructuring methodologies over the last three years since the Asian economic crisis started. The past year has seen many banks take court proceedings against a substantial number of defaulting customers. The incidence of fraud in trade finance transactions appears to have risen in the light of the economic downturn. Receiverships and other insolvency techniques to enforce on collateral whether in Hong Kong or elsewhere remain a useful tool in this respect. As many insolvent Hong Kong businesses have mainland Chinese assets and operations, enforcing against and realizing these remain a challenge for creditors and their advisers alike. Yet, in the case of financial restructuring, banks have been exposed to a variety of mechanisms for dealing with problem debtors ranging from concerted legal proceedings to exposure haircuts in debtors' favour, from court supervised schemes of arrangement to exchanging debt exposure for shares in a corporate debtor, and from dealing with white knights to dealing with other unyielding banks with differing interests.

Year 2001

A robust banking system underpins Hong Kong's competitiveness as a financial centre and is a solid foundation for its greater role in the international economy. With personnel changes at the top governmental level, the ex-Financial Secretary, Donald Tsang, who is no stranger to forging policies for the Hong Kong economy, recently succeeded Anson Chan as Hong Kong's Chief Secretary for Administration upon her retirement. Antony Leung, a seasoned banker, takes over the mantle from Tsang as Financial Secretary, and with it the hope that the Hong Kong economy will perform steadily this year. Yet with significant changes globally and in the banking market, banks are set to remain cautious about the prospects for 2001.

Koo and partners
Solicitors & Notaries

22/F Bank of China Tower
1 Garden Road
Hong Kong

Tel: 852-28679988
Fax: 852-28681017
E-mail: awyc@kooandpartners.com
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