Are Hong Kong lenders under threat as virtual banks zero in on their market?

The HKMA has received 29 applications in the first round of screening ending August 31.

The conservative banking industry in Hong Kong is getting a much-needed makeover as the city’s top regulator prepares to grant the first online-only banking license as early as Q4 2018 or Q1 2019 as part of its comprehensive digital blueprint for the financial services sector.

The Hong Kong Monetary Authority (HKMA) unveiled revised guidelines on the authorisation of such entities in May. So far, a total of 29 applications have already been received in the first round of applications ending August 31, according to local media reports, as a motley array of fintech, telecomm operators, retail banks, stored value facilities (SVF) license holders and Chinese tech giants are gunning to wrestle market share from the SAR’s old-guard banks.

Confirmed applicants include Standard Chartered Bank, online lending platform WeLab, a consortium led by CASH Financial Services Group, Zhong An Bank allied with China Citic Bank and HKT, a joint venture by Bank of East Asia, Airwallex, and Sequoia Capital China.

With no need to set up branches, these virtual entities will deliver the full suite of retail banking services which can range from extending loans, operating savings account, issuing cards and offering payment services through an app or a website - although they are required to maintain a level of physical presence like service desks with which to address customer inquiries and interface with the HKMA.

“It’s a big step for Hong Kong because this allows for new market entrants providing pure digital banking, and in a city which has historically experienced relatively traditional financial services. This shift is accelerated by non-traditional players [applying for the license], leveraging new technology and distribution mechanisms, rather than incumbent banks undergoing digitisation,” Marc Entwistle, director at the Fintech Association of Hong Kong (FTAHK) and Asia-Pacific FinTech Strategy at EY.

Taking inspiration from a number of global initiatives including Europe’s PSD2 regulation, the city’s dedicated virtual banking push signals its commitment to cement its leadership in the banking scene and capitalise on the growing number of residents embracing mobile for their financial needs.

“Virtual banks can offer better pricing and services because they do not have legacy operations and technology costs. In virtual banks, middle and back office functions are coupled together seamlessly,” said Sankar Krishnan, executive vice president, banking and capital markets, Capgemini.

Virtual banks will be subject to the same level of minimum paid-up capital requirements of $300m that their retail counterparts need to meet to be able to operate in line with the Banking Ordinance. They are also required to invest heavily in cybersecurity and information security frameworks especially as there is not much in the way of back-up when there are no physical branches to fall back on, noted Entwistle.

The HKMA also requires applicants to produce an exit plan that will enable them to gracefully unwind their business and turn over their customers without causing disruption to the financial system in the event that they shut down operations.

Entwistle notes that it is likely for this reason that a lot of tech players have been forming joint ventures to pursue a banking license as they pool their capital, tech and managerial expertise should they graduate from being startups to full-fledged virtual banks.

“At the end of the day, we’re not talking about startups anymore - we’re talking about the banks. Banks are something that the Hong Kong public have to trust because you’re giving them your payroll. Sometimes, it’s acceptable for startups to fail but it’s not acceptable for a bank to fail,” said Entwistle.

Are banks threatened?
With fintechs fast encroaching in on their territory, do entrenched Hong Kong banks have reason to fear? A recent report by market research firm J.D. Power revealed that more than half (57%) of Hong Kong customers have expressed readiness to try out virtual banks as they lament growing problems with their existing e-banking platforms with 35% encountering problem with their online banking account and 56% experiencing difficulties with their mobile banking app.

More than a third (32%) of customers are also considering switching from their main banks which might suggest higher levels of dissatisfaction compared to their peers in Singapore (18%) and Australia (16%), creating fertile ground for virtual banks.

Banking on first-mover advantage, Standard Chartered has decided to throw its hat early on in the race as it sets up a separate entity in support of its virtual banking ambitions.

“People do not want another account with a different brand, they want their financial lives simplified. That is why we believe that the launch of a virtual bank will give clients the choice of going completely digital for their everyday banking needs,” Samir Subberwal, regional head, retail banking, Greater China and North Asia, said in a statement.

Other banks are instead choosing to direct their resources to digitising their core services like DBS Bank who was quoted in a local media interview in July that it doesn’t “feel the need to launch a virtual bank” as it makes headway on its existing digital initiatives.

“DBS Hong Kong might change opinion if SC eats its market quota. I understand DBS might not need to do so in Singapore since it is one of the large incumbents but, in my opinion, it should follow SC’s strategy,” said Alicia Garcia-Herrero, chief economist for Asia Pacific at Natixis.

However, there is no better time for Hong Kong’s traditional lenders to take advantage of this opportunity especially as they command the lion’s share of the banking market and any new player will still have to first work at chipping away at their dominance in addition to other problems that are unique to their nature as digital entities.

“Aging is a roadblock [for virtual banks] which is why it is easier for banks with physical presence to launch a parallel strategy based on virtual banking but much harder for those newcomer which do not count on such physical platform,” Garcia-Herrero added.

Despite the massive market potential, a number of banks are still weighing their options as they study the strengths of going the virtual banking route amidst their ongoing digital efforts.

“Bank of China (Hong Kong) will proactively drive financial innovation and study the feasibility of virtual banking development, in order to provide customers with diversified banking services,” the bank said in an emailed statement.

Hang Seng Bank echoed the sentiment in an emailed reply. “With regard to applying for a virtual bank licence, we are conducting a review based on various considerations, including market conditions, the needs of our customers and whether the development of a virtual bank would complement our existing business.”

Capgemini’s Krishnan, however, believes that it is only a matter of time as banks get onboard the virtual banking train.

“In five years’ time, all banks will be virtual banks, as they re-platform themselves by connecting to each other’s platforms, creating a giant utility,” he forecasted. “Almost all traditional banks are applying for virtual bank licenses in Hong Kong, so the stage is being set for a lot of competition that will hopefully benefit consumers.”

On its own, the virtual banking guidelines already represent a massive step forward for Hong Kong’s banking sector. However, the initiative is only one of seven digital efforts spearheaded by the HKMA to future-proof the city’s financial services sector for the digital age. Other initiatives in the programme that are expected to come online this year include the formulation of a policy framework on open API rules; a Faster Payment System that will go live in September to encourage the use of mobile phone numbers or email address for HKD and renminbi payments; and enhancing the fintech supervisory sandbox.

“There’s a shift along multiple fronts which are pushing Hong Kong into a very positive direction,” observed Entwistle. “It’s down to who will move fastest, who can innovate fastest.”