Foreign bank branches
The minimum asset size criterion is important because it acts as a proxy for the quality of the entrant. A bank of this size should, in practice, have the management and systems to be able to control overseas operations. It should be noted that the assets size of US$16billion allows access by the world’s 333 largest banks13, of which 105 are represented in Hong Kong. However, asset size is not always a good indicator of asset quality and prudence of bank management, which ultimately affects the banks’ safety and soundness.
The asset size criteria also restrict certain niche market banks, with assets of below the US$16billion minimum, from obtaining a full bank licence. However, the HKMA has the power to relax this requirement if it considers it appropriate to do so to promote the interests of Hong Kong as an international financial centre. These banks can also enter the Hong Kong market in the form of an RLB, for which authorization is not subject to the size criteria.
13 Source: Bankers, July 1997
Locally incorporated banks
The difference between the minimum asset size criteria for local banks (HK$4billion) and foreign banks (US$16billion) is significant. However, in general, domestic banks are smaller than international banks and are under the direct home supervision of the HKMA. Therefore, it would not be appropriate to set the same assets size criterion for both foreign and local institutions. It should also be noted that there is a minimum deposit criterion of HK$3billion for local banks.
The size criteria for locally incorporated banks provide transparent targets for RLBs and DTCs to meet in order to upgrade to a full bank licence. Similar to the size criterion for foreign banks, the size of a deposit base and assets demonstrate a reasonable degree of management experience and systems in place to compete in the domestic market.
Minimum capital requirements
Foreign branches
The fact that foreign branch banks have so much access to the local banking market has raised some concerns in that they do not presently need to keep any minimum capital in Hong Kong. Local banks, in particular, see this as being an unfair competitive advantage and consider that foreign banks should have the same capital requirements as local banks. One specific view expressed by bankers in this respect was that the specific CAR requirement set by the HKMA, which is in excess of the Basle 8%
minimum, is higher than the requirement on foreign banks set by their home supervisor.
When a form of branch capital is required, this can, broadly speaking, be divided into the following two main types:
Ø Branch capital – a set minimum capital requirement for a foreign branch bank, which may (or may not) be similar to the minimum capital requirements for a locally incorporated bank.
Ø Quasi branch capital – maintaining a set minimum amount of head office funds (e.g. long-term loans from the parent bank), which is in effect capital, although it may not be represented in the balance sheet as such (e.g. represented as long-term intra-group borrowings).
The principal reasons for branch capital or quasi capital requirements include:
Ø It demonstrates commitment by the parent bank – similar to minimum capital requirements for locally incorporated institutions, a certain level of capital investment from the parent bank represents a level of commitment to the local banking sector.
Ø Capital investment – certain countries seeking long-term foreign capital investments use this as a means of achieving economic objectives (e.g. maintenance of a capital account surplus).
Ø Depositor protection – requiring a capital cushion or certain holding of assets is a method of ensuring that in the event of liquidation, sufficient funds would be available to effect repayment to depositors.
The level playing field issue is also quoted as a reason to require branch capital.
However, this is more appropriately viewed in the context of capital adequacy regimes, rather than a minimum capital requirement. All authorized institutions operating in Hong Kong are subject to a similar capital adequacy regime. For example, locally incorporated institutions have set minimum ratios, while foreign banks applying for entry must, in general, meet (on a continuing basis) a minimum capital adequacy ratio of 8% (calculated in a way which is consistent with the Basle Capital Accord) at the parent bank level. However, foreign branch banks have more flexibility in that they can leverage off their parent bank’s capital, which is likely to be larger than most local banks, and therefore can aggressively expand (or contract) their balance sheets in Hong Kong. The imposition of branch capital does not resolve this issue, as foreign branch banks would also need to be subject to minimum capital and local capital adequacy ratios. Imposing such a requirement is likely to detract from Hong Kong’s position as an international financial centre.
In view of the fact that the investment cost of opening a branch in Hong Kong already represents a strong degree of commitment from the parent bank, there is no apparent need to require branch capital to further demonstrate this commitment. In fact, requiring capital may work against the objectives of attracting a broad range of foreign participants to Hong Kong, especially in the light of the current economic circumstances surrounding a number of Asian countries which have reduced the attractiveness of the region as a whole.
Hong Kong permits a free flow of capital and, therefore, imposing a branch capital requirement could be seen to be some form of capital control. This was a point that was commented upon by several foreign banks.
One of the more important issues in Hong Kong is the case for improved depositor protection in case a bank fails. Requiring some form of branch capital may appear as one way of dealing with this issue in relation to a foreign branch bank. However, this needs to be viewed in terms of the liquidation process applicable in Hong Kong (for details see Section 1.6).
Under the liquidation framework in Hong Kong, requiring some form of branch capital would be less effective at improving depositor protection than, for example, an asset maintenance requirement14. In a liquidation, the surplus assets of the branch (i.e. after deducting priority claims) would be applied equally for the benefit of all creditors world-wide. Therefore, increasing the potential amount of surplus assets, by imposing a branch capital requirement, may benefit priority claims depositors but not others. In addition, the liquidator would only have jurisdiction over Hong Kong-based assets of the branch. However, the potential increase in surplus assets that branch capital may
14 Asset maintenance – a requirement to maintain a certain amount of specified assets (usually in Government bonds or other liquid assets) either deposited at the central bank or in a commercial bank. The amount of assets required to be maintained is generally set in relation to the deposit taking activity of the branch (e.g. 5% of total third party liabilities).
provide is affected by the amount of assets in Hong Kong. An asset maintenance requirement would be a more direct way of dealing with this issue (i.e. to try to ensure that there are sufficient surplus assets in Hong Kong to pay-off priority claims depositors in a liquidation of a branch bank).
Based on the above, there is no strong case for requiring foreign branches to maintain capital in Hong Kong. However, the issue of asset maintenance would warrant further consideration from the point of view of depositor protection (see Section 1.6).
Locally incorporated institutions
The minimum capital requirements for local banks were last increased in 198915, partly to take account of the change in the value of money since 1981 and, for RLBs, to reflect the additional status and privileges granted to them when they replaced the then second tier of licensed DTCs. The effective inflation since 1989 has been 95%. The effectiveness of the level of minimum capital in ensuring that new entrants have sufficient financial backing has therefore been substantially diminished.
At present, the average ratio of shareholders’ funds to assets, for locally incorporated banks, is around 8.71%16. For a newly incorporated bank meeting the minimum capital (HK$150million) and minimum assets (HK$4billion) requirements, this ratio would be 3.75%. In practice, the minimum capital requirement therefore appears low in comparison to the minimum assets criteria.
Associated with Hong Kong and time period criteria
In granting an authorization for a locally incorporated bank, the HKMA will take into account factors such as the historical association of the institution with Hong Kong. A foreign bank entering Hong Kong would not, in practice, be able to set up a local bank subsidiary immediately as they need to have operated as an RLB or DTC for at least ten years. However, a foreign bank may either wholly acquire or partially invest in an existing locally incorporated bank, with the approval of the HKMA. In fact, this has occurred a number of times since 197817.
Since the association with Hong Kong and time period criteria were introduced, a significant number of foreign banks have entered the market and there is little evidence that restricting them to branch status only has deterred new market entrants. A principal reason for this is that foreign branch banks do not have to hold any capital in Hong Kong, which provides them with greater flexibility. This is evidenced by the fact that there are certain foreign branch banks (with multi-branch licences) which, due to their long involvement with Hong Kong may meet the criteria for local incorporation but have not approached the HKMA to do so18. For example, Standard Chartered Bank has been present in Hong Kong well in excess of ten years and remains a foreign branch
15 Source: Annual Report 1989 – Commissioner of Banking
16 Source: KPMG Banking Survey Report 1997-98
17 For example, Wells Fargo invested in Shanghai Commercial Bank, Abbey National and Hambros invested in D.A.H. Private Bank, Guoco Group purchased Dao Heng Bank and Overseas Trust Bank and Arab Banking Corporation purchased International Bank of Asia.
18 There is currently no provision in the Ordinance to allow a foreign branch bank to convert to a locally incorporated bank and this would need to be addressed if there was pressure from foreign banks that would otherwise qualify.
bank with 85 branches as at March 199819. Therefore, few foreign institutions, which meet the requirements to establish a fully licensed bank branch, are likely to prefer establishing locally incorporated bank subsidiaries.
The fact that foreign banks cannot, in practice, incorporate locally does have certain drawbacks from a supervisory point of view because less supervisory control can be exercised locally. For example:
Ø minimum capital adequacy ratios are set by home country supervisors;
Ø the lead regulator is domiciled outside Hong Kong; and
Ø the same level of financial disclosure may not be applicable.
In particular, disclosure of financial information is important in terms of providing transparency of institutions to depositors, to assist in decisions regarding with which institutions to place their funds. This is especially true in Hong Kong, where foreign banks have a substantial market presence.
Ownership
The ownership restriction for locally incorporated banks reflects the need to ensure that only fit and proper persons are able to set up or own a deposit taking institution. This is particularly important in view of the additional fiduciary duties that such institutions have to their depositors as well as their shareholders. There have been numerous cases world-wide where poor bank management or unqualified owners have caused depositors to lose their money (e.g. The Bank of Credit and Commerce International).
The ownership criterion restricts the ability of non-banks (both domestic and foreign entities) to set up a bank and compete as new participants. However, as noted earlier, there are a number of exceptions to this criterion in the case of existing locally incorporated banks20. Additionally, such non-banks are allowed to participate in joint venture arrangements or as minority shareholders, provided that they meet the requirements to act as controllers.
It should be noted that Hong Kong, when compared to other international financial centres, is unusual in terms of the extent to which foreign branch banks actively participate in retail banking. In most other developed financial centres, this is the preserve of domestic banks (i.e. those that are locally incorporated). In this broader context, Hong Kong must be viewed as an open market with few barriers to entry.