Deregulation and the Hong Kong Banking Sector

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Deregulation and the Hong Kong Banking Sector

• David Carse
• Hong Kong Monetary Authority
• 31 August 2001

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The current situation of Hong Kong banks

• Banks are currently struggling to achieve profit
  growth
• the economy is slowing down
• loan demand is sluggish
• lending margins are under pressure
• bad debt provisions are falling, but not by as
  much as in 2000

3
Pre-provision operating profit and post-tax
profit (local banks)
4
Net Interest Margin (local banks, annualised)
5
Customer deposits and loans for use in HK(local
banks)
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Competition

• Hong Kong banks are facing growing competition
  due to
• global trends
• increased emphasis on return on capital
• lack of loan demand, particularly for residential
  mortgages
• surplus domestic liquidity
• Regulatory initiatives have also played a part in
  removing potential barriers to competition
• last stage of deregulation of HK interest rates
  took place on 3 July 2001

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History of interest rate deregulation

• Phase one
• 1 October 1994 - time deposits gt 1 month
• 3 January 1995 - time deposits gt 7 days
• 1 November 1995 - time deposits gt 24 hours
• Phase two
• 3 July 2000 - 24 hour call deposits
• 3 July 2001 - current and savings accounts

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Banking sector reform

• Phase Two of interest rate deregulation is part
  of a banking sector reform programme announced in
  1999 to cover period to end-2001
• Objectives are to
• promote greater efficiency and innovation in the
  market
• enhance the safety and soundness of the banking
  sector
• encourage consolidation of the industry through
  market forces
• Apart from interest rate deregulation, rules on
  entry of foreign banks have also been relaxed

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Impact of latest round of deregulation

• Imposition of fees and charges
• Tiering of interest rates on savings accounts
• New types of account
• interest-bearing current accounts (only one bank)
• combined current and savings accounts
• auto-sweeping service
• HIBOR-linked savings accounts
• Most banks have now reduced standard savings rate
  (1.5) by more than prime rate
• Limited evidence so far of switching of deposits
  between banks

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Assessment of the impact so far

• Product innovation has happened as expected
• Other developments (like tiering of rates and
  fees and charges) were also expected
• part of the process of more efficient pricing
• The surprise is that the savings rate has not
  risen as expected
• But this simply reflects the current surplus
  liquidity
• In the longer-term banks will probably compete
  more actively for deposits

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Consumer protection

• The imposition of fees and charges has led to
  accusations of unfairness, particularly to small
  depositors
• However, HKMA does not believe that this
  justifies regulation of banks charging policies
• Main focus is on ensuring transparency on
  charging
• Code of Banking Practice recently revised
• Banking Ombudsman may also be looked at
• Need also to monitor for possible signs of
  growing exclusion from the banking system

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The way forward for the banks

• The economics of banking in Hong Kong are
  changing fundamentally
• This means that banks will have to do the
  following
• broaden income sources (e.g. through sales of
  unit trusts, insurance etc)
• control costs (e.g. through outsourcing of back
  offices)
• improve risk management
• consolidate through MA
• take advantage of the opportunities provided by
  the Mainland

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Local Hong Kong banks presence in China

• Hong Kong banks count as foreign banks in China
• Currently, 11 HK banks have a total of 38
  branches in 13 cities of China
• Mainly confined to foreign currency business with
  foreign companies and individuals
• Three banks have licences to do limited RMB
  business in certain cities

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Relaxation under WTO

• Upon accession all restrictions on foreign
  currency business by foreign banks will be
  removed
• Within two years, foreign banks will be allowed
  to do RMB business with Chinese companies,
  subject to geographical restrictions which will
  be progressively relaxed
• Within five years, foreign banks will be able to
  do RMB business with all Chinese customers
  (including individuals) and geographical
  restrictions will be removed

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Impact of WTO accession on Hong Kong banks (1)

• Banks in Hong Kong (both local and foreign) will
  benefit from increased demand for banking
  services in China
• This will result partly from the impact of WTO on
  Chinas economic growth and partly from the
  liberalisation within China
• ability and willingness of the Chinese public to
  use the banking system will increase

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Impact of WTO Accession on Hong Kong banks (2)

• However, local HK banks will also face more
  competition for China-related business from both
  domestic Mainland banks and foreign banks
• Also, there is a risk that direct access by
  foreign banks to the Mainland will become more
  popular and that HK will be bypassed
• HKMA study suggests that creation effect of WTO
  will outweigh diversion effect
• But local HK banks cannot take this for granted
• competition from Mainland banks is already evident

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The impact of size

• Even with WTO relaxation most local HK banks will
  be limited in their ability to open new branches
  in the Mainland
• Current rules mean that only foreign banks with
  assets of at least US20 billion can set up new
  branches
• Most HK banks are too small to meet this
• This is another reason why consolidation of the
  local banking system would be desirable

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Conclusions

• The new deregulated environment in Hong Kong and
  the increased competition in a slowing economy
  are creating big challenges for banks
• These challenges are long-term and strategic in
  nature, apart from the immediate issue of how to
  achieve profit growth
• Hong Kong banks are strong and resilient
• But even so, structural changes in the form of
  industry consolidation are likely to be necessary