The HKMA (Hong Kong Monetary Authority) recently completed a public consultation on “Virtual Banking” and has formulated its finalised framework for companies looking to apply for a Virtual Bank licence.
The key date for Hong Kong’s virtual banking to finally take off is 31 August, the deadline for submitting applications for the first batch of licences. A number of companies are seeking to make use of the virtual banking platform set forth by the HKMA.
However, it is worth considering some of the key concerns that surfaced during the HKMA’s public consultation, in particular, financial inclusion, data, supervision, exit plans, and other requirements.
The risk of virtual banks with minimum deposit requirements on accounts was opposed by the HKMA, and rightly so, as income disparity in Hong Kong is very high. In general, a virtual banking approach should enable low cost products which are scalable. This also sets a good example of a regulator that speaks up for the weakest members of the public and gives everyone a fair opportunity to bank, especially given the hurdles small business owners currently face in opening bank accounts.
Today, traditional banks have in place minimum balance requirements on accounts, with some going as low as HKD 10,000 and monthly fees of HKD 100 and above. However, there can be significant differences depending on the policies at individual banks. The process usually involves making an appointment request by phone, followed by an in-person meeting. The account opening pack is handed over during the meeting, with the applicant being asked to destroy the pack if the application is not successful. It typically takes about two weeks to process the application with an overall probation period of two months to get the account confirmed.
Considering the outlined process, opening up a bank account in Hong Kong is expensive and time consuming, and it may be that owning a business isn’t for anyone. Selling arts and crafts or other small home business producing low cost food items will need to carefully consider whether revenues will cover the cost of just maintaining a bank account. Today’s banks should take up the fight for financial inclusion and rethink how they can reach more for less. It would certainly do good for young professionals who like the idea of running a company. Virtual banking may be the answer for banks to scale into other customer segments.
With the rapid growth in today’s landscape of digital service providers, the appetite for data has reached staggering levels, wherein several problems emerge. Beyond the obvious need to protect data produced by the customer, banks are presented with issues in collecting, processing and sharing such data with third parties.
Third-party companies develop deep know-how in their domains and have started to build data sharing and volumes into business model development. This means that banks will have to get used to the idea of having multiple links to third parties that potentially access data at all sensitivity levels to supporting cutting edge digital services. Clients on the other hand, may simply get overloaded with all the disclaimers and additional fine print they will be advised to read, similar to the policies that most consumers tend to not read even for standard terms and conditions that are just a few pages long.
Virtual banks will have to think about accountability when it comes to customer data, as large-scale data sets can be derived from multiple areas and in various resolutions. The impact of banks and third-party service providers using customer metadata to enhance services may cause discomfort to many customers – if they came to know about it. Most banks need high resolution management information data to understand sales behaviour and the impacts of marketing campaigns; a two-liner with revenue and turnover will not be sufficient. Sharing data at higher resolution will reverse anonymisation efforts, and the risk of identities being re-engineered is real. The idea of sharing customer data in complete anonymity for companies with third-party links seems unfeasible.
It would appear that further improvements in the HKMA virtual banking guidelines will be needed to take this into account. The guidelines require banks to treat customer information according to the Personal Data Privacy Ordinance, with additional security controls and other measures in place. However, customer protections under the existing guidelines do not consider business platform setups that need large data volumes from banks to function whereby such platforms could potentially be used by third parties to generate conclusions on the customers of their clients. The risks of a bank losing control over how they interact with their customers and of regulators being toothless due to conflicting laws across multiple jurisdictions are more real than ever.
The evolution on supervision towards virtual banks will be interesting to understand further. The question will evolve around customer data and virtual banks’ ability to build on strong third-party services that enable product development beyond banks’ traditional comfort zones.
The thought of having supervision in one place to effectively deal with a number of service providers scattered all over the world may prevent supervisors from falling asleep at night. Not only will they have to supervise the virtual banks in their jurisdictions, but no effort should be spared in monitoring the broader ecosystem of service providers engaged with any such virtual bank.
That, on the other hand, may be beyond the capacity of a supervisor such as the HKMA and it could have an adverse effect to the virtual bank economy if a third-party provider starts to be one of the key elements in the relationship with the virtual bank. Gaining additional thoughts from supervisors on this topic may be key.
Supervision of virtual banks should evolve towards an understanding of applicable business models. A virtual bank should not be a glossy front-end environment that connects to old legacy systems, nor should it be an empty shell connecting to multiple third-party vendors.
The idea of an exit plan for virtual banks was said to be divided. An exit plan for businesses per se is nothing new. Any company should have an exit plan in mind prior to setting up a business and this should form part of internal risk mitigation strategies. However, it’s probably a novum for a regulator to call for such a plan publicly.
The question here is, what is a feasible exit plan for some of the participants and how should such a plan be shared with their business partners? The missing element from the supervisor’s point of view is the fact that a virtual bank could have viral growth and thus present a systemic risk if an event occurred forcing it to enter resolution or shut down. The impact to the clients and public may be of different magnitude than traditional banks in their current capacity.
The smooth execution of an exit plan may then also require virtual banks to have contracts with third parties that allow for quick dismantling and could potentially be the cause for greater risk premiums if third party providers were to accept such pre-conditions for engagements. The question here is one of complexity and should be shared with the public for assurance.
During the consultation period, several respondents requested the HKMA to lower the HKD300 million minimum paid-up capital requirement for virtual bank applicants. However, the supervisor noted that due to this stipulation in the Banking Ordinance, it is applicable to all licensed banks and “it is neither possible nor appropriate to lower the minimum capital requirement for virtual bank licensees.”
All things considered, applicants should consider themselves lucky that the capital requirement in the original 2000 edition of the guideline, set at HKD16 billion for foreign entities, was not adopted.
In Chapter 9 of the virtual banks guideline, a point worth highlighting is that, according to HKMA, “A virtual bank applicant, if authorised, must maintain a physical presence in Hong Kong, which will be its principal place of business here. This is necessary to provide a point of contact with the bank in Hong Kong for both customers and the MA (Monetary Authority)”
Operating a physical presence can have advantages to the HKMA and the customers of virtual banks. This approach may solve some of the current challenges on regulatory oversight and offer to clients a last point for escalation, if a “virtual bank” decides to have all processes entirely in a digital form. The question is, if such an approach for clients will transform into an optional requirement once effectiveness of services have been proven. The next evolutionary step would be to have virtual banks become truly virtual.
Hong Kong introduced a legal framework in January 2000 to address digital hurdles for the e-commerce market. In November 2002, the Legislative Council Panel on Information Technology and Broadcasting published a review paper on the Electronic Transaction Ordinance (ETO) (CAP. 553). The discussions were mainly centred on having a PIN (Personal Identification Number) as means of a digital signature and suggested the legal framework should be “technology-neutral”.
Reading through the discussion within the paper, it is remarkable how the public responded and understood the strength on a technology neutral approach. Nevertheless, the ETO did not completely digitise the landscape in Hong Kong. There are still few exemptions to be found in Schedule 1, with the Power of Attorney being quite a significant one. Will banks customers find virtual banking less useful if there are fewer functions included in the banking service?
It will be interesting to understand how quickly current banks can adopt a “digital-first” approach and truly live up to it – even internally. The market share on payments and lending in the financial sector speaks to banks as the leading institutions in the race, but technology companies that have a wide range of products on offer may have the skills and experience in the digital ecosystem to compete even better. What digital companies understand is that building smart machines can make processes and operations intelligent.
A major step forward
Hong Kong has done well in acting to open opportunities for companies to realise their digital ambitions in the banking sector. It will not only benefit new entrants and technology companies in continuing their growth in Hong Kong, but it will drive existing banks to rethink processes, rules of engagements and outsourcing protocols to enable some of their existing client segments in a new digital environment.
The authorisation process for Virtual Banking in Hong Kong seems no separate channel from the existing path to engage with the regulator and set up a traditional bank. The cost to new market entrants is high, and ultimately new entrants to the Hong Kong banking scene may emerge from existing operators or those established in other markets in the region.
Let’s remember one thing, whilst virtual banking may be still all new to Hong Kong, customers in the US, Europe and China are familiar with it. Hong Kong may have been slow to the game in finalising its framework for virtual banks, but digitisation in the city is now on the move. This is good news and critics should recognise this as a major step forward for Hong Kong.
Philip is a financial engineering expert by training with extensive background in wealth management. He began his career at UBS AG in client advisory before transitioning to project management. He currently works in financial services as a consultant with Capco.