Financial Crisis: Threat or Opportunity

Financial Crisis: Threat or Opportunity for Banks in Hong Kong

Impacts Of Financial Crisis To HK Banks

It was reported on March 15th, 2010, that Hong Kong shares "rose early Tuesday, shaking off fears about monetary tightening by China that dragged down the market in the previous two sessions as banks and resource stocks advanced after broad overnight gains on Wall Street." (Market Pulse, 2010) in 2008 the banking environment in Hong Kong was characterized by government assistance directed toward backing bank deposits totally $773 billion through 2010. The Hong Kong Monetary Authority had stated at that time that it was "prepared to provide capital to the territory's 23 locally incorporated banks, following the example of the United States and Britain." (Bradsher, 2008)

Hong Kong banks were stated to be among "the most heavily capitalized in the world…" (Bradsher, 2008) it was claimed by the financial secretary of Hong Kong, John Tsang that the Hong Kong banking system was both "healthy and robust" but that however, Hong Kong banking must make preparations for a rainy day." (Bradsher, 2008) it is additionally stated that Hong Kong would "back its deposit guarantee with its foreign exchange reserves, now $161 billion." (Bradsher, 2008) This work will examine the impact that the subprime mortgage crisis of 2008 in the United States had on the Hong Kong Banking Industry.

II. RETAIL BANKS in HONG KONG

A. BEFORE FINANCIAL CRISIS

The work of Hall, Kenjegalieva and Simper (2008) entitled: "Environmental Factors Affecting Hong Kong Banking: A Post-Asian Financial Crisis Efficiency Analysis" states "The Asian Financial Crisis (AFC), which erupted in Thailand during the Summer of 1997 and went on to cause such economic and financial devastation in the region in ensuing years, has been well documented (see, for example, Goldstein (1998) Hunter, Kaufman and Krueger (1999), and Jao (2001). Hong Kong was one of just a few countries in the region to escape relatively unscathed, successfully avoiding a banking crisis although, of course, some damage was inflicted on the banks." (Hall, Kenjegalieva and Simper, 2008)

Hall, Kenjegalieva and Simper (2008) additionally report that there was indirect damage inflicted on the real economy by the AFC a banking crisis was still avoided. Only one local bank is stated to have "slipped into the red" which is stated to be "in stark contrast to the experience of 1983-86 when a major banking crisis occurred due to a collapse in asset prices and specifically due to "the uncertainty surrounding Hong Kong's transition from a British Crown Colony to a Special Administration Region of the PRC, mismanagement including over-exposure to the property sector and fraud. Hong Kong Banks are stated to have dropped in profitability sharply with stabilization failing to be established until the fourth quarter of 1999." (Hall, Kenjegalieva and Simper, 2001)

The three-tier banking system was implemented in 1990. Market entry criteria for foreign banks were also relaxed in May 2002. Such, then, was the nature of the more liberal regulatory environment within which Hong Kong's banks operated post-1999, and the banks have been able to engage in renminbi-dominated 'retail' banking operations since January 2004. It is reported that the focus should likely be on that of the interest rate liberalization program and relaxed market entry criteria.

It is also reported that the Hong Kong Monetary Authority noted as early as 2002 that "the increased competition had resulted in a reduction in bank lending spreads, particularly in the mortgage loan market, and downward pressure on net interest margins, particularly for small banks. Some banks, however, and especially the larger ones, managed to offset such adverse effects on profitability by boosting non-interest (i.e. fee and commission-based) income and reducing operating costs by, for example, encouraging customers with low and volatile balances to use less-costly delivery channels, such as the Internet. Account charges are now also the norm. As far as the smaller banks are concerned, the introduction of deposit insurance in 2006 should have acted to increase the relative attraction of small licensed banks by reducing the competitive advantage enjoyed by "Too-Big-Too-Fail" banks; whilst many also view deposit deregulation as an opportunity allowing them to compete more effectively for deposits with large listed banks. Finally, the opening-up of some renminbi-denominated business to Hong Kong's licensed banks in January 2004 has served to provide these banks with some additional revenue, despite the PRC's stringent capital controls. Moreover, the Chinese government's subsequent decision to relax exchange controls by allowing Mainland banks to issue renminbi-denominated credit cards which can be used at ATMs in Hong Kong should further boost fee income for the latter region's banks." (Hall, Kenjegalieva and Simper, 2001)

B. AFTER FINANCIAL CRISIS

It is reported in the work of Daniel Po-min Chan (2008) in the work entitled: "Hong Kong Faces Sub-prime Contagion" published in the Hong Kong Journal that despite the resilience of the Hong Kong economic outlook, that the story is quite different in the property and stock markets in that the "outbreak of the subprime crisis increased the possibility of having negative real interest rates." (Chan, 2008) the Hong Kong currency is stated to be "pegged to the U.S. dollar…" (Chan, 2008) it is reported that local banks in Hong Kong lowered their rates to only 3% and inflation was stated at approximately 5% therefore the result is that the "local real estate market has seen negative lending interest rates…creating a favorable environment for real estate investment." (Chan, 2008) Problematic are residential property prices which rose "so dramatically…that these can be difficult to sustain." (Chan, 2008) in addition, it is reported that the local lending rate was expected to "bottom out despite a further U.S. rate cut in April." (Chan, 2008)

Hong Kong is one of the fastest growing of all world international finance centers servicing its domestic economy as well as China and the Southeast Asian region." (Hall, Kenjegalieva and Simper, 2001) the banking industry of Hong Kong is reported to be "robust with 68 of the world's 100 largest banks having a presence" in Hong Kong. There are presently the following types of banks doing business in Hong Kong:

Licensed Banks

Restricted License Banks

27

Deposit Taking Companies

28

Owned by Sovereign Entitles

29

Included in the three-tier system of deposit-taking institutions in Hong Kong are the following:

(1) Licensed banks: In Hong Kong, only licensed banks can operate current and savings accounts, accept deposits of any size and maturity from the public and pay or collect checks drawn by or paid in by customers. There are currently 23 licensed banks incorporated in Hong Kong and 125 licensed banks incorporated outside Hong Kong.

(2) Restricted license banks: Restricted license banks are principally engaged in merchant banking and capital market activities. They can take deposits of any maturity of HK$500,000 (approximately U.S.$64,103) and above. There are currently 14 restricted license banks incorporated in Hong Kong and 12 restricted license banks incorporated outside Hong Kong.

(3) Deposit taking companies: Deposit taking companies are owned by or otherwise associated with banks. These companies engage in a range of specialized activities, including consumer finance and securities business. They may take deposits of HK$100,000 (approximately U.S.$12,821) or above with an original term of maturity of at least three months. There are currently 28 locally incorporated deposit-taking companies. (Janus, 2010)

Joseph Yam, Chief Executive of the Hong Kong Monetary Authority at the Joint HKAB stated in his "Reflections Relevant to the Banking Profession in Hong Kong" that the well-capitalized banks in Hong Kong have fared well as they were "well prepared for shock. Crisis management, particularly when public confidence momentarily came under strain, was effective. The generally cautious approach of our bankers, your refusal to get carried away by innovation, helped minimize the damage: this is a vindication of your reputation for prudence, and a great credit to Hong Kong's banking system. We also seem to have achieved a good balance in the relationship between the supervisor and the banking system. "(Yam, 2009)

Yam relates that a primary example of "how that balance has contributed to banking stability is the 70% loan-to-value policy for residential mortgage lending by banks. This policy, now a cornerstone of our prudential arrangements, pre-dates even the foundation of the HKMA and evolved out of a productive dialogue between HKAB and the supervisor. It has survived strong political pressure for relaxation and market pressure for innovative credit risk transfer through securitization. The policy -- now nearly two decades old -- fits in well with the macro-prudential approach which, particularly in the light of the recent crisis, supervisors in other jurisdictions now consider to be essential to banking stability. The fact that no such policy existed in the advanced financial systems is remarkable enough. But what is more remarkable is the level of initiative of the Hong Kong banking sector itself in seeing the importance of systemic stability and giving it precedence over the profitability of individual institutions." (Yam, 2009)

Yam observes that there is a real need to "move with the times" and states that the past 12 months have "seen a plethora of ideas and proposals for reforming financial regulations, and interventions by government that were unprecedented in their nature and scale." (2009) Yam states that over the past year the need existed to involve the government more deeply in the banking industry and especially in the area of deposit guarantees and in the supervision of the risk management of banks. Yam states that it is "…gratifying that so many of the tools that we have been able to rely on, including the apparatus and contingency arrangements for ensuring liquidity, have been developed in a pre-emptive rather than a reactive way. On the various emergency measures, I am quite sure that in the fullness of time, these will either be turned into standing arrangements or withdrawn, hopefully through smooth exit strategies. but, current sentiment is clearly demanding much closer regulation and supervision of banks over the longer term." (2009) the form that this will take is stated to be pending in the international forums however Yam states that the thinking thus far "…seems to be towards improvements in the level and quality of banks' capital; new global standards for measuring, managing and supervising liquidity risk; and macro-prudential supervision to reduce the pro-cyclical dynamics of financial markets. No doubt the details will take some time to work out." (2009)

As an international financial centre, Hong Kong must adopt international standards and best practices. We have to move with the times, although that does not of course mean we have to blindly implement everything in an inflexible, straightjacket manner. (Yam, 2009) Hong Kong is stated to be in a good position "to adopt and participate in the various measures now under consideration by the G20, the Financial Stability Board and its Standing Committees and other international agencies." (Yam, 2009) Yam reports that a primary cause of the recent financial crisis was "the use -- or abuse -- of innovation by financial intermediaries for short-term private gain at the expense of longer-term stability and effective working of the financial system as a whole." (2009)

Trends of Hong Kong Banking Industry

Hong Kong's banking sector in the 1990s was characterized by the domestic market structure being highly concentrated and dominated by the HSBC Group. Measures introduced by the Hong Kong Monetary Authority (HKMA) to support the position of Hong Kong as an International Finance Center and to open the foreign banking market. The following measures were introduced by the Hong Kong Monetary Authority (HKMA):

In 2001 it lifted all restrictions on the number of branches that foreign banks could maintain in Hong Kong.

In 2002 it lifted the market entry criteria for foreign banks. Previously, to be considered for a banking license, a foreign bank had to maintain a representative office for 1-2 years in Hong Kong. Foreign banks also had to satisfy the U.S.$16 billion asset size criterion. Recognizing these criteria as impediments to the expansion of its international financial services market, the HKMA dropped the representative office requirement and relaxed the balance sheet size criteria to HK$3 billion for customer deposits and HK$4 billion for total assets.

Overseas banks that do not qualify for a full banking license were allowed to establish Restricted Licensed Banks and Deposit-Taking Companies in order to conduct wholesale and investment banking practices.

Furthermore, a number of liberalization measures have been introduced from time to time under the Mainland and Hong Kong Closer Economic Partnership Arrangement (CEPA). The new measures benefit Hong Kong's banking industry, providing market entry and business expansion opportunities in the Mainland.

The Hong Kong banking industry has experienced growth in the private banking industry and as well is one of the primary world wealth management centers and claims the largest private banking market in Asia experiencing robust growth in the past several years. (, 2010)

III. STRATEGIC MODELS on HK BANKING INDUSTRY

A. PORTER FIVE FORCES

ONE: Existing competitive rivalry between suppliers

Because the Hong Kong banking industry is superior to the majority of banking systems in terms of its stability it is not likely that competitive rivalry is a primary factor at this juncture.

TWO: Threat of new market entrants

Market entry criteria for foreign banks were also relaxed in May 2002. Such, then, was the nature of the more liberal regulatory environment within which Hong Kong's banks operated post-1999, and the banks have been able to engage in renminbi-dominated 'retail' banking operations since January 2004. It is reported that the focus should likely be on that of the interest rate liberalization program and relaxed market entry criteria. There will likely be new entrants in the international banking industry

THREE: Bargaining power of buyers

Buyers will hold great bargaining power in the environment of today's banking industry of Hong Kong and Hong Kong banks just as other banks will be striving to offer their customers what the customers need, want and expect in terms of products and services.

FOUR: Power of suppliers

The government and regulatory environment will play a large role in the offerings of products and services by Hong Kong Banks.

FIVE: Threat of substitute products (including technology change)

Yam (2009) noted in his speech that the role of Hong Kong in serving the need of China in international finance depend on the pace of financial liberalization on the Mainland particularly in the development of the renminibi business. Yam reports that it is out of the hands of the banking industry because involved are policies that allow greater cross border mobility of capital, financial instruments and financial intermediaries. Yet our survival as an international financial centre depends on our being prepared for these policies of financial liberalization." (2009) Yam recommends that the banking industry should be proactive in "…offering advice in policy making and be ready to provide assistance and technical support in policy implementation. One very practical way of doing this is to continue to use our financial system as a platform for cautious experiment in the gradual liberalization of the renmminbi -- a process that is of benefit to our system and to the nation as a whole."

B.

PEST ANALYSIS

Political

Regulatory reform is driven not just by objective circumstances but also by changing public expectations.

Banks are operating in a "more skeptical, more demanding, even hostile environment. (Yam, 2009)

Economic

As an international financial centre, Hong Kong must adopt international standards and best practices. (Yam, 2009)

Social

The social factors that are relevant to the Hong Kong Banking Industry are presently unknown.

Technological

There is discontent and anxiety locally that pre-dates the crisis -- for example, about access to banking services, about the risks of new technology -- that result partly from the changing business landscape and partly from changing expectations. We must expect this trend to continue, and it will be necessary for the banking industry and the regulator to take more and more account of wider public opinion, and to tackle areas of concern. (Yam, 2009)

C.

SWOT ANALYSIS

Strengths

Strong domestic banking market dominated by the HSBC Group that has become a strong international financial institution in its own right.

Growth of foreign banks that was facilitated by a number of initiatives such as lifting restrictions on the number of branches a foreign bank could maintain and lifting restrictions on eligibility criteria for grant of banking licenses to foreign banks.

Regulatory authorization for a wide range of banking services from deposit taking, trade financing, loan syndication to foreign exchange trading.

Strong emergence of the private banking sector due to Hong Kong's strict anti-money laundering provisions, non-discriminatory low tax regime and availability of sophisticated wealth management services. (Janus, 2010)

Provisions of the Hong Kong private banking industry include Standard Charter Bank and HSBC making provision of services across a wide range including:

(1)

Wealth management;

(2)

Investment advisory;

(3)

Low risk asset growth

(4)

Corporate product support

(5)

Estate planning; and (6)

Others. (Janus, 2010)

The strength of Hong Kong's private banking industry is its anti-money laundering laws and generous tax incentives. Other strengths include:

(1) no capital gains tax; and (2) No tax on overseas dividend income. Janus, 2010

Investment banking in Hong Kong ahs experienced growth due to Hong Kong being the commercial capital of Asia. Investment services include:

(1) Issuing securities (underwriting);

(2) Managing portfolios of financial assets;

(3) Trading of securities (stocks and bonds);

(4) Assisting investors purchase securities and providing financial advice and support services.

(5) Assisting investors purchase securities; and (6) Providing financial advice and support services. (Janus, 2010)

The private sector bond market in Hong Kong is reported to be among the largest and most liquid in the Asia-Pacific region. Electronic bond trading platforms result in benefits to institutional and retail investors. Responsible for opening the bond market to foreign participants is the listing of the Pan Asia Bond Index Fund on the Hong Kong stock exchange. (Janus, 2010, paraphrased) the securities and futures market in Hong Kong is reported to be "highly regulated." (Janus, 2010) the types of banks in Hong Kong include those that cater to various clientele including:

(1) Individuals;

(2) Corporations/government agencies. (Janus, 2010)

Those listed just previously provide services that are commercial in nature through:

(1)

Retail banking;

(2)

Private banking. (Janus, 2010)

Hong Kong is reported to be one of the largest international representation of banks in the world and 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." (Lowtax.net: Hong Kong Banking and Financial News, 2010) in December, 2007, there were 142 licensed banks, 29 restricted license banks and 29 deposit-taking companies in business. These 200 authorized institutions operate a comprehensive network of 1,600 local branches. In addition, there are 79 local representative offices of overseas banks in Hong Kong. Total Employment in the sector is nearly 80,000. Banking assets amount to more than HKD10 trillion." (Lowtax.net: Hong Kong Banking and Financial News, 2010)