Welcoming the development of virtual banks in Hong Kong

The Hong Kong Monetary Authority’s (HKMA) latest initiative to facilitate the establishment of virtual banks in the city could be instrumental in promoting fintech and innovation, and redefining customer experience.

The HKMA views the development of virtual banks – which deliver retail banking services through the internet or other electronic channels instead of physical branches – as an important initiative to bring Hong Kong into a new era of smart banking, and as a significant factor in the long-term success of the city’s banking sector.

In February it launched a consultation on proposed revisions to the Guideline on Authorization of Virtual Banks issued in 2000. This was followed by the results of the consultation and the final version of the revised guidelines which was published at the end of May. A key revision includes an indication that non-financial firms may apply to open a virtual bank that is supported by a strong parent – not necessarily a financial institution – to provide managerial, financial and technology support. This revision changes the original guidelines, which required virtual banks to be at least 50 percent owned by a well-established bank or other financial institution.

Enhancing customer-focused digital services

The revised guidelines open the door for new players to set up a virtual bank in Hong Kong, and we are already seeing significant interest from a range of companies, including fintech start-ups, large technology companies and other large corporates. The HKMA indicated in their 30 May press release that they have received expressions of interest from more than 50 potential applicants. The nature of virtual banks will likely create an advantage from a cost perspective, and will also help drive financial inclusion in Hong Kong by targeting the retail segment, including small and medium-sized enterprises.

While many traditional banks already have well-developed mobile and online banking platforms, we anticipate that allowing technology companies to set up virtual banks will significantly raise standards in the industry and enhance the sophistication of the technology used.

These new entrants should provide significant impetus for traditional banks to innovate, work with innovative start-ups, forge strategic partnerships and adopt the latest fintech solutions and technologies to enhance their service offering and improve customer experience. Hong Kong’s close proximity to Shenzhen – where some of the world’s most innovative fintech developments are taking place – is further enabling both incumbents and new entrants to study and capitalise on these opportunities. This benefit is enhanced by the ongoing development of the Greater Bay Area in Southern China, where a key focus is the transformation of the region into a global technology and innovation hub.

Many fintech companies have developed innovative technology that can enhance the overall customer experience, lower the costs of financial products and facilitate the granting of loans to consumers who otherwise do not have the credit history to obtain finance from traditional banks. This could significantly boost financial inclusion and encourage traditional banks to further develop their own platforms and customer-focused digital services, thereby raising the bar across the entire banking sector in Hong Kong.

A new approach to risk management

While the revised guidelines will encourage the development of virtual banks, the HKMA remains focused on ensuring that the new entrants meet the regulations that apply to existing banks, particularly around capital, risk management and governance requirements. From our experience working with a number of digital and challenger banks in mainland China, Europe, the US and Australia, we find that their strong emphasis on technological innovation, agile development and simple and targeted products require a new and dynamic approach to conduct and risk management.

With technology at the core of a virtual bank’s operations, the risk profile of a start-up virtual bank will vary from traditional banks. For example, while a successful cyber attack is a serious matter for an established traditional bank, it could strike a fatal blow to the reputation of a virtual bank. Furthermore, given the greater use of open application programming interfaces and partnerships with third parties, data protection is another area which needs to be carefully addressed. In an environment where all customers will soon be able to withdraw money in an instant online (and are used to doing so), any issues are amplified.

Meanwhile, from a conduct perspective, there are also new risks arising from the targeting of potentially vulnerable customer segments which have previously been underserved by traditional financial institutions.

Adopting a new approach to risk management can also bring benefits to both virtual banks and traditional banks, as well as their customers. For example, technology used to on-board customers and address know your customer and anti-money laundering requirements can be integrated with the overall platform in a much more efficient way. This would allow virtual banks to operate safely, and could also benefit a number of existing banks that have established electronic platforms to reduce the costs of their risk and compliance structure.

For their part, Hong Kong’s regulators will also need to consider adapting some of the existing regulatory requirements to address this new approach to risk management, balancing the need to maintain a safe banking system against an imperative to encourage innovation, enhanced customer service and financial inclusion.

With the revised guidelines generating significant interest in the market, the companies that apply for a virtual bank licence need to ensure that they carefully develop an appropriate business plan to put in place all of the systems, controls and processes to meet the HKMA’s requirements. Existing financial institutions should also view the emergence of virtual banks as a catalyst to innovate, adopt new technologies, and enhance their online and mobile platforms to improve customer experience and boost the overall competitiveness of Hong Kong’s banking industry.

Overall, we believe that the establishment of virtual banks is a welcome development that will lead to significant new opportunities for the banking sector in Hong Kong. In ten years, we may see a very different competitive landscape, with a healthy mix of new entrants and traditional players offering an exciting new customer experience and further propelling Hong Kong’s status as a regional fintech innovation hub.

This article was co-authored with Tom Jenkins, Partner, Financial Services, KPMG China. If you would like to know more about our perspective on Hong Kong’s banking sector in 2018, please read the full report here.