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The Future of Banking in Hong Kong - the Impact
and Implications of Internet Banking

• David Carse
• Deputy Chief Executive
• Hong Kong Monetary Authority
• 14 June 2000

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The Age of the Internet

• Ignore the hype about dot.com companies
• The internet is here to stay and will
  revolutionize banking
• Banks that neglect the internet do so at their
  peril
• How to handle the challenge posed by the internet
  and technology in general is the biggest
  strategic issue in banking

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The potential in Hong Kong

• Internet banking will succeed in Hong Kong
  because there is the supply, the demand and the
  infrastructure
• Penetration rates for electronic delivery
  channels are among the highest in the world
• over 50 of households have PCs
• 80 of households have access to broadband
• 55 of the population use mobile phones
• about 30 of the population are internet users
• Electronic Transactions Ordinance provides legal
  basis for electronic commerce
• recognition of digital signatures and
  certification authorities

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The current situation

• So far about 14 banks have introduced
  transactional internet banking services either
  directly or using the JETCO virtual ATM service
• More are planning to do so in the near future
• Main focus at present is on the consumer (B2C),
  including on-line stock broking
• But a number of banks are also exploring
  business-to-business opportunities (B2B),
  including bill presentment, payment services and
  trade finance

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The economics of the internet

• The internet offers banks the chance to cut costs
  and to increase revenue through more effective
  marketing and cross selling
• But cost savings are expected to be minimal over
  the next few years
• Spending will increase on front and back-end IT
  and associated expenses such as advertising
• though the operating expenses seem manageable for
  the time being - average of about 1.5 of annual
  total
• Revenue gains from cross-selling are uncertain
• Margins will come under pressure from greater
  price transparency

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The strategic challenge for the banks

• Despite the uncertain benefits over the next few
  years, the banks have no alternative except to
  embrace the internet
• Internet capability will be necessary to provide
  credibility (respect rather than revenue) and
  to fend off new, low-cost entrants
• virtual banks
• e-lenders
• portals and aggregators

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The nature of the dilemma

• For many institutions the Internet is a
  double bind. Embrace it, and you may still find
  yourself losing business, or at least seeing
  profit margins dwindle. But ignoring it could be
  terminal.
• The Economist

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The strategic opportunities

• Despite the threats, banks are not defenceless
• multi-channel distribution (including via
  revamped branches) seems the best model at
  present
• the virtual bank model is unproven
• e-lenders need to obtain funding
• established customer base and brands are
  important
• online banking from a company thats been around
  longer than a week (American Express)
• But the banks need to get it right
• must be greater focus on quality of service (ease
  of access, range of products, degree of
  personalization)
• must migrate customers to low-cost channel
• must integrate front and back-end systems

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Security risks

• Although banks face all sorts of security risks
  day to day, the internet poses new challenges
  because of its open nature
• Security is the biggest concern among customers
  and therefore the biggest barrier to customer
  acceptance of internet banking
• The technology does exist to provide protection
  but it requires continuous review and upgrading

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Reputational and legal risk

• Successful hacking of a system or system
  breakdown may cause bad publicity and undermine
  customers confidence in internet banking even if
  they suffer no loss
• If customers do suffer loss it is necessary to
  determine how this should be apportioned between
  them and the bank
• terms and conditions should be clear and fair
• customers should be warned of their
  responsibilities on security
• customers should not be responsible for direct
  losses due to security breaches etc unless they
  have acted negligently or fraudulently

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Banking risks

• The internet may heighten the risks inherent in
  conventional banking, eg
• liquidity risk may increase if depositor loyalty
  is reduced and/or it becomes easier for
  depositors to transfer deposits at the touch of a
  button (the virtual run)
• credit risk may increase if the relationship with
  the customer becomes more distant and transitory,
  or if competitive pressures lower credit
  standards
• However, the enhanced ability to gather and
  interpret customer data can reduce these risks
• reinforces the need for banks to enhance their
  management of customer data

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The role of the HKMA

• The HKMAs role as regulator is to help minimize
  the risks of internet banking while not standing
  in the way of progress
• This requires us to upgrade our own skills, eg by
  hiring examiners with specialist IT knowledge

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The regulatory framework

• Existing banks seeking to offer an internet
  banking service should consult with HKMA in
  advance
• security is a major supervisory issue
• Banks should also keep us in touch with plans for
  internet joint ventures - need our consent for
  investments of 5 or more of capital base
• New companies wishing to take deposits in Hong
  Kong (including virtual banks) require
  authorization under the Banking Ordinance
• note that the ability to set up a new local bank
  from scratch is limited under the current law

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The regulatory framework (2)

• Issuers of smart cards also require authorization
  under the Banking Ordinance
• E-lenders, portals and aggregators need HKMAs
  consent to use a banking name
• Offshore internet banks should comply with rules
  on advertisements directed at persons in Hong
  Kong

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Virtual banks

• Some local banks have already indicated their
  intention to set up separate virtual banks
• HKMA has recently issued a Guideline on VBs
• objective is to accommodate VBs without
  disruption to the system
• Underlying theme is to remind sponsors that VBs
  must have substance rather than simply be
  concepts
• VBs are subject to the same risks as conventional
  banks and should be subject to the same
  prudential criteria
• Dont be blinded by the technology!

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Key features of our Guideline

• VBs must fully address the various risks to which
  they are exposed (including security)
• need for independent assessment of security
  controls
• Appropriate balance to be struck between
  acquisition of market share and earning a
  reasonable return
• Local VB cannot be newly established except
  through conversion of existing local AI
• Local VB should be at least 50 owned by a well
  established bank

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Offshore internet banks

• One of the features of the internet is that it
  removes physical boundaries
• Will make it easier for overseas banks to use the
  internet to attract offshore deposits from Hong
  Kong residents
• In doing so, they should comply with our
  advertising rules but,
• how to enforce?
• what is the legal position of ISPs who transmit
  advertisements?
• Cross-border cooperation with other regulators
  will become more important
• Meanwhile, depositors should beware!

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Conclusions

• Internet banking is clearly the way forward for
  the banking industry and the banks in Hong Kong
  are well placed to capitalize upon this
• However, the task of managing the change will not
  be an easy one and the economic benefits, in the
  short-term at least, are uncertain
• It will be another factor in increasing the
  intensity of competition in Hong Kong and it may
  help to accelerate the industry consolidation
  which must inevitably come