Hong Kong: Banking

Hong Kong has one of the largest representation of international banks in the world: 71 of the world's 100 largest banks have a presence there. Hong Kong is the world's 9th largest international banking centre in terms of the volume of external transactions, and the second largest in Asia after Japan. The banking sector plays a vital role in establishing Hong Kong as a major loan syndication centre in the region.

The banking sector, being the major participant of the Hong Kong foreign exchange market, contributes to Hong Hong's status as the world's 7th largest foreign exchange centre.

At the end of September 2011, there were 151 licensed banks (128 of which were incorporated outside Hong Kong), 19 restricted licence banks (of which seven were incorporated outside Hong Kong) and 26 deposit-taking companies in business (all incorporated in Hong Kong). These 196 authorised institutions operate a comprehensive network of 1,300 local branches. In addition, there were 65 local representative offices of overseas banks in Hong Kong.

Total Employment in the sector is about 80,000. Banking assets amount to more than US$1 trillion.

The banking system in Hong Kong is characterized by its 3-tier system, which is formed by 3 types of banking institutions, namely licensed banks, restricted licensed banks and deposit-taking companies, which are authorised to take deposits from the general public. The 3-tier of deposit-taking institutions operate under different restrictions. Only licensed banks and restricted licensed banks can be called banks.

Hong Kong's banking sector is highly open, being the second largest international banking centre in Asia after Japan in terms of the volume of external transactions.

The success of the SAR's banking and financial services economy is largely a consequence of a non-discriminatory low tax regime. Business profits are taxed at a maximum rate of 16.5% whereas employees pay a maximum tax on salaries of 15%. Low tax rates are complemented by the absence of a number of types of taxation. Thus (save in very limited circumstances) there are no withholding taxes, no taxes on interest, no capital gains taxes, no sales tax or VAT; and income arising outside the jurisdiction is not taxable in Hong Kong under the "territorial principle". Deductible allowances are equally generous.

China

A major liberalization measure went into effect in January 2011 under the Closer Economic Parntership Arrangement (CEPA) between Hong Kong and China.

Under CEPA VII, which took effect on January 1, 2011, is that a Hong Kong bank that has maintained a representative office in China for more than one year can now apply to set up a wholly foreign-funded bank or a foreign bank branch. A Hong Kong bank's operating institution in China can apply to conduct renminbi business, if it has been operating for more than two years and has been profitable for one year prior to the application. Additionally, the asset requirement for Hong Kong banks to establish on the mainland is being reduced to HKD6 billion (from HKD10 billion), making it easier for many of the SAR’s banks to set up in China.

During the last few years the Chinese authorities have been racing to clean up major domestic banks, which were weighed down with bad debts and clunky administration.

The liberalization of China's banking market has been a slow process, and by December, 2006, only eight foreign banks had applied for retail banking licenses in mainland China, as the country opened its banking market under WTO rules it agreed five years previously.

By June 2011, there were 127 foreign banks in China, but until recently most of them were limited to handling foreign currency business. In 2010 foreign banks accounted for just 1.83% of the country's total banking assets, or RMB1.7 trillion, up from 1.7% in 2009. Locally-incorporated foreign banks now total 40, and data from the China Banking Regulatory Commission shows that they accounted for 87% of all foreign banking assets at the end of 2010.

Nonetheless, foreign banks operating in China are "surprisingly confident" about their prospects in the Chinese market according to a 2011 report by PwC, entitled 'Foreign Banks in China', which found that most foreign banks expect revenues to grow over the next three years as the Chinese economy opens up to foreign investment and the central government takes steps to liberalize the renminbi.

In addition to organic growth, PwC's report concludes that foreign banks are pursuing strategic partnerships and making acquisitions where possible in many different parts of the financial sector.

"Indeed, it is the inevitability of this gradual defined process towards greater internationalisation of the economy that is underpinning the foreign banks' optimism. They believe that the opening up of the economy and the transition to a convertible currency must lead to increased opportunities for foreign banks," the report states.

However, the report found that while foreign banks believe that China offers "rich opportunities", they will only be able to exploit these opportunities if the playing field is level and China's regulators continue along their liberalising path.

The report identified a select group of six six banks which are said to be ahead of the competition in terms of customer base and branch networks. These banks include Hong Kong's Bank of East Asia, Hang Seng Bank, Citibank, DBS Banks, HSBC and Standard Chartered. This group estimates that they will collectively operate a network of 500 branches and sub-branches by 2014. A second group of corporate and investment banks has also emerged, according to PwC, which includes some major European and American institutions. The report additionally observed the emergence of a third group of mainly Asian banks with close trading and business links with China, and a fourth group of banks of various sizes from around the world that are focussing on niche markets such as wealth management, trade financing and foreign exchange.

The 42 banks interviewed for the report expect to grow employment by more than 50% by 2014, to over 52,000 people.

A Memorandum of Understanding was signed in August 2003 by the Hong Kong Monetary Authority (HKMA) and the China Banking Regulatory Commission (CBRC) to strengthen supervision of banks operating on both sides of the border. HKMA operates in effect as Hong Kong's Central Bank, while the CBRC was formed earlier in the year to take over banking supervisory responsibility from the People's Bank of China. The 15-department CBRC says its major responsibilities include "formulating supervisory rules and regulations for banking institutions, (and) authorizing the establishment, changes, termination, branching out and business scope of banking institutions.'' It is also responsible for dealing with problem deposit-taking institutions. The MoU calls for the two regulators to share supervisory information for banks operating in China and Hong Kong and they will work together to ensure that a parent bank exercises "adequate and effective" control over the operations of cross-border branches and subsidiaries. They will also meet formally twice a year.

Liberalization of the Yuan

2003-2006

In September, 2003, China's central bank chief Zhou Xioachuan was in Hong Hong to discuss the possibility of the territory's financial institutions formally accepting yuan deposits. In November that year, it was announced that banks in Hong Kong would soon be permitted to offer certain renminbi-denominated services, as part of the ongoing initiative to deepen economic ties between the territory and the Chinese mainland. Banks will be allowed to accept deposits, arrange remittances, issue credit and debit cards, and make foreign exchange transactions. However, they were not, initially at least, able to offer corporate banking services.

Although recent estimates have suggested that there is between RMB20 billion and RMB70 billion circulating in Hong Kong, the jurisdiction's banks have traditionally been unable to access the cash due to foreign exchange restrictions and capital controls imposed by the mainland authorities. Hong Kong's then chief executive, Tung Chee-hwa welcomed the move, hailing it as a "very important step to consolidate our position as an international financial centre".

Analysts also considered this an important first step towards Hong Kong becoming an offshore yuan trading centre. "The integration between the two places will be closer and closer, so that means that renminbi will co-circulate with the Hong Kong dollar in Hong Kong going forward," said Chris Leung, senior economist at DBS Bank, "Obviously, if that's the case, there's sort of a demand for renminbi storage with the banks. So it's a natural development, but the problem is there are many technicalities and contradictions in order for this to become a reality," Leung added.

In February 2004, the eagerly anticipated move to liberalise trading and exchange of the yuan in Hong Kong took its first step forward after the city’s banks were given the go-ahead to begin taking deposits in the Chinese currency.

With billions of dollars worth of yuan notes floating around in the city, Hong Kong banks are using a variety of incentives to potential customers in a bid to suck in some of this (previously illegal) surplus cash. They will be helped by the fact that interest rates on yuan deposits will be higher than those on the HK dollar, reflecting the rate of interest on the mainland.

Under the relaxed rules, banks were able to exchange up to 20,000 yuan a day ($2,400) per individual provided the transaction is conducted through a deposit account. Meanwhile, cash transactions were limited to 6,000 yuan, and individuals may remit up to 50,000 yuan per day back to their accounts in China.

However, the changes far from represented a fully liberalised exchange system, and tight restrictions remained on the Chinese currency in the city. For instance, the new rules will only allow Hong Kong residents and those with a Hong Kong ID card to make yuan bank deposits, whilst companies will remain barred from banking the currency.

In April, 2004, the Bank of China Hong Kong announced that it would begin issuing credit cards and bank cards for use with the yuan. The yuan-based credit and ATM cards were the first to be issued in the city since restrictions on the circulation of the Chinese currency in Hong Kong were relaxed earlier in the year. Several other banks were also preparing to launch their own cards at this time.

BOC Hong Kong, chosen by the Chinese authorities to act as the central clearing bank for all yuan services in the SAR, additionally revealed that the new cards will be connected to China’s UnionPay payment network, used by some 400,000 merchants and 50,000 ATMs on the mainland.

2007-2010

The first renminbi bond issue by a Mainland financial institution came in 2007. In July of that year, the China Development Bank (CDB) announced that the subscription result of the first issue of renminbi bonds in Hong Kong reflected a strong response from both retail and institutional investors, with an oversubscription rate of nearly two times.

To facilitate the issuance and trading of renminbi bonds in Hong Kong, the Real Time Gross Settlement system and Central Moneymarkets Unit have been upgraded to handle the related settlements of renminbi funds and trading of renminbi bonds respectively. The recently introduced renminbi interbank transfer service and use of renminbi cheques in Hong Kong have operated smoothly during the subscription process, signifying the enhancement of the capabilities of local banks in handling renminbi financial transactions.

The Treasury Market Association has also commenced work on the arrangements for renminbi bond price fixing and repo documentation, which will be conducive to the development of a secondary market for renminbi bonds in Hong Kong.

After Chinese Premier Wen Jiabao announced in Singapore, in November 2007, that he did not agree with the cash withdrawal limits placed on Shenzhen banks, they were hastily withdrawn, leaving the underground pipeline that has been sustaining Hong Kong's booming stockmarket in full flood.

"The Shenzhen banks' motives are good but they could employ better methods," said Wen. "We should have taken measures that were more effective and that were acceptable to the public."

The Chinese authorities are of course fully aware of the flow of illegitimate cash to Hong Kong, caused by Chinese exchange controls, and they are under heavy pressure to liberalize the renminbi. It was this that had led to the now-abandoned 'through-train' proposal to allow investment in Hong Kong stocks through defined channels.

Shenzhen banks had set a daily withdrawal limit of Renminbi 30,000 on personal accounts. "If the illegal fund flow is not controlled, it will affect the financial stability in the country, including Hong Kong," Wen said, but it's not clear what action Beijing will now take.

It's not just the official banks that operate the pipeline: the local equivalent of hawali money-exchange networks are involved, and there are many parallel unofficial links between individuals. In fact the border is so porous that it's difficult to see how some form of liberalization can be avoided. Local estimates are that the daily flow of cash between Hong Kong and Shenzhen amounts to several billion renminbi.

In August 2010, the People's Bank of China (PBoC) announced that eligible institutions outside the Mainland could take part in a pilot scheme to make use of their renminbi (RMB) funds to invest in the Mainland's interbank bond market. Under the scheme, banks participating in RMB business in Hong Kong can conduct trading in the Mainland's interbank bond market upon approval by the PBoC. Chief Executive of the HKMA, Norman Chan, said: "The launch of the scheme has opened up a channel for RMB funds and financial institutions in Hong Kong to invest in the Mainland. This will further promote the development of RMB trade settlement in Hong Kong, and enhance the attractiveness of RMB offshore business in Hong Kong."

On November 22, 2010, Sun Xiaoxia, Director-General of the Finance Department of the Ministry of Finance (MoF), and Mr Eddie Yue, Deputy Chief Executive of the Hong Kong Monetary Authority (HKMA), signed a "Memorandum of Co-operation on Using Central Moneymarkets Unit for Issuance of Renminbi Sovereign Bonds" in Hong Kong, setting the foundation for the tendering and issue of renminbi sovereign bonds through the CMU BID, a bond tendering platform offered by the Central Moneymarkets Unit (CMU) operated by the HKMA.

According to the HKMA, this move "manifests a deepening of financial co-operation between the Mainland and Hong Kong, and will widen the channel and enhance the methodology and environment for the issuance of renminbi sovereign bonds."

Chan of the HKMA, said: "The CMU tendering platform has served us well in the past 17 years. It is where the primary issues of the Exchange Fund Bills and Notes and the Government Bonds are tendered. It helps increase market transparency and facilitates price discovery. The signing of the Memorandum by the MoF and the HKMA on using the CMU to conduct tendering for the issuance of the renminbi sovereign bonds marks a milestone of the strengthening of financial co-operation between the Mainland and Hong Kong."

The CMU is operated by the HKMA. It serves as a platform for tendering, clearing and settlement of bonds. The tendering of renminbi sovereign bonds through the CMU is the system’s first tendering of bonds denominated in renminbi.

That same day, the Ministry of Finance of the People’s Republic of China announced that a tender of three-year, five-year and ten-year RMB Bonds of the Central People’s Government would be held on November 30, 2010 for settlement on December 1, 2010.

A total of RMB2bn three-year Bonds, RMB2bn five-year Bonds and RMB1bn ten-year Bonds were to be made available for competitive tender on a coupon-bid basis by any qualified Central Moneymarkets Unit members through the CMU BID, a bond tendering platform.

The Bonds were to be issued at par value and will mature in 2013, 2015 and 2020 respectively, on the last interest payment date of the relevant series of Bonds. Each series of Bonds will bear interest at the uniform annual issue interest rate for the relevant series determined through the competitive tender (i.e. the highest accepted interest rate for the relevant series), payable semi-annually in arrears. Each tender must be for an amount of RMB500,000 or integral multiples thereof and the difference between any specified tender interest rates should be at least 0.01%, rounded to two decimal places.

2011

The State Administration of Foreign Exchange (SAFE), in a short statement, has confirmed that it will look for a developing use of China's currency, the yuan, in capital account transactions this year.

While it will continue its close monitoring of capital account flows, it is now to be expected that convertibility of the yuan for cross-border investment purposes will mirror the use of the yuan for cross-border trade settlement, which is already much further developed.
It was reported that it is also proposed to extend the trial of yuan-denominated cross-border trade settlement to all cities in China by the end of this year. The central bank has said that such settlement reached a total of more than CHY506bn (USD77bn) in 2010. In addition, by the end of the year, more than 67,000 Chinese companies had joined the yuan settlement programme.

Hong Kong has previously confirmed its involvement in the development of the yuan’s capital market utilization being contemplated by SAFE. Cross-border yuan trade settlement handled in Hong Kong reached CHY370bn last year, and Hong Kong has also seen progress in other yuan-denominated areas, including deposits, bond issuance and the introduction of financial products.

Hong Kong maintains close contact with SAFE to further develop Hong Kong’s yuan bond market. As at end-January this year, there were a total of 31 yuan bond issues with an issuance size of about CHY74.4bn. The range of issuers has expanded from Mainland financial institutions to multinational non-financial institutions.

Anti-Money Laundering

Alongside liberalisation of the yuan market, the Hong Kong Monetary Authority (HKMA) has urged banks in the jurisdiction to be alert to the possibility of money laundering as they gear up to offer yuan-denominated banking services. "Participating banks are requested to heighten the awareness of their staff involved in such business to possible money laundering transactions," the regulator announced. In order to reduce the possibility of money laundering activity taking place, the HKMA ordered banks to record whether yuan deposits are made in cash, or via the conversion of other currencies.

It also urged the financial institutions to keep track of multiple accounts opened by the same customer, and to ensure that the 20,000 yuan per day exchange limit is not breached by spreading the transactions across several accounts.

On this front, the Hong Kong Securities and Futures Commission (SFC) entered into a MoU with the CBRC for co-operation and information sharing with respect to Hong Kong licensed intermediaries who provide services to Mainland commercial banks conducting overseas wealth management business on behalf of their clients

The MoU was signed on April 10, 2007, in Hong Kong by Eddy Fong, Chairman of the SFC and Liu Mingkang, Chairman of the CBRC and took immediate effect.

“The MoU is conducive to further enhancement of the regulatory co-operation framework. It provides a solid foundation for the commencement of effective regulatory co-operation," stated Liu. "Through mutual assistance and information sharing, we can promptly identify risks, and take timely regulatory measures to protect the interests of investors.”

The Hong Kong Security Bureau has said that from January 26, 2007, remittance agents and money changers must verify customers' identities, and record transactions of HKD8,000 (about USD1,000) or more. They must also verify the identity of anyone who receives a remittance of HKD8,000 or more.

The requirements aim to meet the new international standards with regard to combating money laundering and terrorist financing.

Customers must produce their Hong Kong identity cards - or certificate of identity, document of identity or travel document - for verification, and provide their addresses and telephone numbers.

Agents and money changers must also record and retain the particulars of the sender and the instructor of any transaction if the two are not the same person.

Accounting Standards

Two new accounting standards came into force in Hong Kong in January 2005. At more than 320 pages with an additional 214 pages of implementation guidance, Hong Kong Accounting Standards 32 and 39 are detailed and prescriptive in nature.

The new accounting standards require banks to estimate loan provisions based on future cash flows rather than the previous guidelines issued by the Hong Kong Monetary Authority, and review the basis for general provisioning. Most banks hold a general provision of around 1% of total advances, as required by the Hong Kong Monetary Authority. The new standard requires this to be based on an analysis of historical loss experience and may lead to a significant write back of general provisions. The standards are the Hong Kong Society of Accountants' final step in achieving full convergence with International Financial Reporting Standards. In achieving full compliance Hong Kong banks will be more comparable with their international peers, facilitating easier access to cross border capital markets.

Deposit Protection Scheme

Hong Kong’s enhanced deposit protection scheme, (DPS) providing a higher protection limit of HKD500,000 (USD64,300), from a previous limit of HKD100,000, came into operation on January 1, 2011.

In addition to the increase in the protection limit per depositor per bank, the scheme also now includes deposits pledged as security for banking services. However, as restricted-licence banks and deposit-taking companies are not members of the scheme, the scheme does not cover deposits placed with those institutions.

The Full Deposit Guarantee provided by the Government was introduced on 14 October 2008, which guarantees all deposits held with authorized institutions (i.e. all licensed banks, restricted licence banks and deposit-taking companies) until the end of 2010. This special guarantee was a contingency measure introduced at the onset of the global financial crisis in late 2008 to reinforce confidence in Hong Kong’s banking system.

The Financial Secretary, John Tsang, said the full deposit guarantee had functioned effectively to shore up public confidence in Hong Kong's banking system during the global financial crisis, but “as the global economy has become more stable, the provision of this special guarantee by the government should come to an end as originally planned."

The Chief Executive of the Hong Kong Monetary Authority, Mr Norman Chan, said, “Our banking system remains healthy and robust, with capitalisation well above international standards. Public confidence in the banking system has also remained strong. The expiry of the Full Deposit Guarantee is not expected to have any impact on the banking system.”

The Hong Kong Deposit Protection Board has undertaken extensive publicity campaigns since the second half of 2010 to raise public awareness on the changes, including their understanding on the coverage under the enhanced Scheme. Close collaboration with banks has been maintained to ensure that they make timely adjustments to their systems and business flows. Furthermore, the Board has worked closely with the HKMA as the banking regulator to remind Authorized Institutions to make proper representation on the expiry of the full deposit guarantee and its potential impact on their customers.

Mrs Chan Wong Shui, Chairperson of the Board, said, "The enhanced Deposit Protection Scheme stands ready to provide a means of protection to depositors. The new protection limit of $500,000 will be able to fully cover about 90% of the bank depositors. The Board has taken the necessary measures to prepare for a smooth transition to the new Scheme."

After the implementation of the enhanced DPS, the Board will continue to maintain an effective and efficient DPS in line with international practice.

Hong Kong's Deposit Protection Scheme was first launched on September 25, 2006, with a coverage limit of $100,000 per depositor per bank.

Enacted on May 5, 2004, the Deposit Protection Scheme Ordinance governs the setting up and operation of the scheme. After two years of intensive preparation,the scheme provided deposit protection and and collected contributions from members from the 25th of that month.

All licensed banks, unless otherwise exempted by the board, are required to participate as members.

The main features of the scheme are that:

• Depositors are not required to apply for protection or compensation, eligible deposits held with scheme members will automatically come under the protection of the scheme;
• Both Hong Kong dollar and foreign currency deposits are protected;
• The scheme protects eligible deposits held in scheme members, it does notprotect term deposits with a maturity longer than five years, structured deposits, secured deposits, bearer instruments, off-shore deposits and non-deposit products such as bonds, stocks, warrants, mutual funds, unit trusts and insurance policies;
• A Deposit Protection Scheme Fund with a target fund size of 0.3% of the total amount of relevant deposits (translating into a fund size of approximately $1.3 billion) will be built through the collection of contributions from scheme members; and
• Differential contributions will be assessed based on the supervisory ratings of individual scheme members.

Members are also required to notify their customers if a financial product described as a deposit is not protected by the scheme.

Capital Adequacy Rules

New Banking (Capital) Rules came into effect in January, 2007, and are the implementing Rules for Basel II, the international standard for banks' capital adequacy.

They set out in detail the different approaches that can be adopted for calculating the capital charge for credit, market and operational risks.

They were issued under a new rule-making power provided under the Banking (Amendment) Ordinance 2005, and replaced the previous regulatory capital regime set out in the third schedule to the Banking Ordinance.

In September 2010, HKMA deputy chief executive Arthur Yuen Kwok-hang suggested that Hong Kong's banks will have few problems complying with the latest changes to international capital adequacy rules known as Basel III. He said that local banks' capital ratios are already well above existing standards, with capital adequacy ratios standing at 15.7% in June 2010.

Under Basel III banks will have to maintain capital adequacy ratios at 8%, but tier 1 capital requirement, which includes common equity and other qualifying financial instruments based on stricter criteria, will increase from 4% to 6% from January 1, 2013 to January 1, 2015. Banks will be required to hold a capital conservation buffer of 2.5% to withstand future periods of stress bringing the total common equity requirements to 7%. The buffer requirement will be phased in from January 1, 2016 to January 1, 2019.

Banking Stability Review

The Hong Kong Monetary Authority (HKMA) announced in December 2007, a review of its work in the area of banking stability, and appointed former Jersey banking regulator, David Carse as consultant to conduct the review.

The aim of the review was to make recommendations on how the HKMA can best discharge its functions in promoting the general stability and effective working of the banking system, taking into account recent and likely future developments in Hong Kong’s banking system, and the changing nature of the risks facing it.

Carse's report, which was published in July 2008, found that the Hong Kong banking system is in "robust" condition. The review concluded that the HKMA is widely respected by the Hong Kong banking sector for its professionalism and effectiveness, and viewed by outside commentators as in the top flight of regulators internationally. No fundamental deficiencies in the regulatory and supervisory framework or processes have been identified. However, the report recommends a number of measures to provide an even sounder foundation to cope with the challenges ahead.

"The global banking system is now facing a new crisis triggered by the problems in the US sub-prime market," the report stated. "Although the Hong Kong banking system has so far been relatively unscathed by this, the HKMA will need to absorb the various lessons to be learned from it and this will to some extent determine its supervisory agenda over the next few years."

A more fundamental issue for the HKMA, the report noted, will be how to manage the growing integration with the banking system on the Mainland.

"The ability to expand into the Mainland will create new business opportunities for Hong Kong banks, which are facing increasing competition in their domestic market, but will also bring with it increased risks. The HKMA will need to ensure that both the banks and itself understand the nature of these risks and that there are adequate means in place to control them. Cooperation with the China Banking Regulatory Commission will be a vital factor in this," the report suggested.

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