PRIMER: Hong Kong’s Virtual Banking Guideline
Similar rules now apply to both online and bricks-and-mortar lenders
What is the Guideline on Authorisation of Virtual Banks?
The Hong Kong Monetary Authority (HKMA) released a Guideline on Authorisation of Virtual Banks at the end of May. These are principles that the HKMA will consider in its approval process for virtual banks to be allowed to operate in Hong Kong. A virtual bank is a bank that offers retail banking services online without physical branches, and a key part of a push for Hong Kong to move into a ‘new era of smart banking’. The deadline for the first batch of applications for interested virtual bank operators is August 31 2018.
What are the key features of the Guideline? According to the document, applicants need to ensure that minimum criteria are met before they are licensed. These include:
Virtual banks must maintain adequate capital and liquidity.
Applicants need to have an independent assessment report on its technology risk, including hardware, systems, procedures and controls to ensure its cybersecurity controls are fit for purpose.
While no physical branches are needed, a virtual bank must maintain physical presence in Hong Kong as its principal place of business.
An exit plan that includes channels to be used to repay depositors and sources of funding for making payments is necessary in case the business needs to unwind.
According to Boo Boon Khoo, co-chair of the digital banking committee at the Fintech Association of Hong Kong, there are a number of challenges for potential new players in the virtual banking space in Hong Kong. One challenge is ensuring the sustainability of the business.
“The new player will need to secure sources of balance sheet funding that can support growth,” said Khoo. “There is a need for the newcomer to continuously maintain its banking propositions to bring value to target customers.”
In addition to meeting increasing enforcement on compliance, anti-money laundering, anti-bribery and corruption laws, Khoo also warns that virtual banks must keep intact on security, fraud and data protection.
What will make potential applicants stand out?
The HKMA has indicated that applicants will be prioritised if they have sufficient financial, technology and other resources to operate a virtual bank. Another factor is whether they have a credible and viable business that would provide new customer experience, and promote financial inclusion and fintech development. Other factors include whether the applicant has developed or can develop an IT platform to support their business plan, and whether the applicant can begin operating as soon as a license is granted.
"Some respondents to the Guideline's consultation questioned the requirement on virtual banks not to impose minimum balance requirements or low-balance fees on customers"
What have been reactions to the guideline? Richard McKeown, partner at Simmons & Simmons notes that in the HKMA’s commentary on the revised Guideline some respondents questioned the requirement on virtual banks not to impose minimum balance requirements or low-balance fees on customers.
“The regulator took the view that a key objective of introducing virtual banks in Hong Kong was to help promote financial inclusion by lowering the incremental cost of taking in additional customers,” he said. “As such minimum balance requirements and low-balance fees should not be imposed on customers.”
He added: “The requirement for virtual bank applicants to produce an exit plan was objected to on the ground that no similar requirement applied to conventional bank applicants.”
The HKMA has reiterated its stance that it is prudent to require an exit plan and similar requirements are also in place in other jurisdictions.
What do potential virtual banks find most difficult about the Guideline?
The minimum paid-up capital requirement of HK$300 million ($38.2 million approximately) for virtual bank applicants is an issue for new players in the market, especially startups, although this is applicable to all licensed banks. McKeown believes that the HKMA’s proposal will likely benefit existing dominant market players and make it more difficult for other perhaps less well capitalised but innovative companies.
"Virtual banks still need to meet the compliance and anti-money laundering requirements just as traditional banks do"
Hoi Tak Leung, counsel at Ashurst observes that among those interested in virtual banking, which can broadly be categorised into existing banks, fintechs and technology players, the capital requirements of HK$300 million challenging would be especially challenging for fintech startups.
On the data transfer requirements for virtual banks, privacy issues may be encountered. “The outsourcing requirements appear to envisage servers/papers and require banks to obtain legal opinion from local counsel in the country to which they will outsource to confirm that the HKMA will have unfettered access to the data,” said McKeown. “Whilst the HKMA seems to be open-minded about the use of cloud technology, it will be interesting to see how they actually apply the existing outsourcing guidelines in a digital world.”
The HKMA has taken the approach of applying strict requirements to virtual banks just as it does to traditional banks. Compared to traditional banks, there is a levelled-playing field for virtual banks’ requirements, for instance, the capital base.
“Compared to traditional banks, there is a levelled-playing field for virtual banks’ requirements, for instance, the capital base,” said Minny Siu, partner at King & Wood Mallesons.
“Virtual banks still need to meet the compliance and anti-money laundering requirements just as traditional banks do,” added Richard Mazzochi, partner at King & Wood Mallesons. “The challenge will be employing the right people, demonstrating that the technology works and that risk mitigation measures are in place.”