The principal purpose of financial disclosure is to allow the forces of market discipline to work more effectively, namely shareholders and depositors can monitor the risk taking activities and performance of banks in order to enable them to make informed investment or business decisions. Other banks (and businesses) can also make more informed decisions regarding business relationships (e.g. exposure limits). Any increase in disclosure should enable more effective monitoring of risk taking activities of banks and this information should be shared among all market participants, including banks, regulators, market analysts and the general public.
The efforts made to improve banks’ financial disclosure were led by the HKMA, working closely with the banking industry and the accounting profession. The results of this initiative are embodied in the Best Practice Guide on Financial Disclosure by Authorized Institutions with which all non-exempt authorized institutions incorporated in Hong Kong are expected to comply.
Foreign branch banks in Hong Kong, on the other hand, are not required to publish any information on their activities in Hong Kong, although they are required to have available in their branches a copy of their parent bank’s accounts. These accounts are prepared and published in accordance with the accounting and regulatory standards of their home countries, which may vary considerably.
The HKMA also recognises that development of financial disclosure is a continuous process in order to ensure that it keeps up with developments of the Hong Kong banking sector. Since 1994, disclosure items have been added to the Guide to reflect developments in the market and to further enhance the quality of information provided.
1.5.2 Assessment of financial disclosure
Improved financial disclosure by local banks has resulted in the financial disclosure by banks in Hong Kong being rated as one of the best in Asia22 and being reasonably comparable with other major international financial centres. This is a significant achievement considering financial disclosure by banks in Hong Kong was rated as one of the worst prior to 1994. As a result, Hong Kong’s banking sector has a good degree of transparency, which assists the market discipline mechanisms to operate effectively.
Increased transparency is beneficial, particularly in the current economic downturn, where banks are disclosing declines in profits and business growth. Full disclosure on the quality of bank assets, funding arrangements, liquidity and capital strength helps to prevent unsubstantiated rumours from gaining credibility during times of economic hardship and market volatility. This is especially relevant in Hong Kong given the propensity for bank runs. Experiences in the region have also shown that transparency has an important role to play at times of volatility (e.g. there have been indiscriminate
22 Source: ING Barings - 1997
runs on banks in Indonesia, including those that were financially sound). Good financial transparency is one of the key strengths of the Hong Kong banking sector.
However, the current requirements are only applicable to locally incorporated institutions, due primarily to the fact that branches of foreign banks are not required to prepare accounts under the Companies Ordinance. This lack of financial disclosure is not commensurate with the market position of foreign banks. For example, several of the 16 foreign banks with significant retail market participation have larger operations and balance sheets in Hong Kong than the smaller local banks. Therefore, a significant proportion of the market does not have the same degree of financial transparency as the locally incorporated banks, which may not enable the market discipline mechanism to operate effectively for the sector as a whole. It is important to note that this situation is not similar to other countries, where the domestic retail market is generally serviced by local institutions. In those countries, foreign branch banks usually do not participate to a great extent in those retail markets.
The lack of information regarding foreign banks’ activities is therefore at odds with the level of market share that they hold and represents a gap in transparency of the domestic banking sector. This is also important from a level playing field aspect, as foreign banks competing in the same market as local banks, have much more information available to them concerning the activities of their competitors than is the case for local banks. This could give foreign banks an unfair competitive advantage.
1.5.3 Comparison with other international financial centres
As mentioned above, disclosure by banks in Hong Kong compares favourably with other countries in the region and is comparable with leading financial centres such as the US and UK.
Disclosure of financial information by local branches of overseas banks is now required in several countries in the region and leading financial centres, including, for example, the US, New Zealand, India, Korea, Thailand, the Philippines, Taiwan and Indonesia.
Additionally, Singapore is proposing disclosure by foreign branches in the near future.
The disclosure requirements in each of these countries vary. For example, some require audited balance sheets, while some require unaudited balance sheets and others require profit and loss accounts.
1.5.4 Views of market participants
The views of banks on the issues of a level playing field and an efficient market discipline mechanism are in general consistent. The results from the banking sector survey indicated that:
Ø 70% of all respondents believed a level playing field between local and foreign banks was important or essential for the sector; and
Ø 85% of respondents considered an efficient market discipline mechanism to be extremely important.
The views expressed by investment analysts (in interviews) indicated that they consider there is room for further improvements in local bank disclosures, although they acknowledge that local bank disclosures are already comparable with other international financial centres. For example, more information on the effectiveness of bank credit risk management (e.g. loan delinquencies and recoveries).
Both banks and other interested parties generally favour more disclosure by foreign branch banks operating in Hong Kong. However, they have noted the need to ensure that any local branch financial information be considered in conjunction with the financial position of the parent bank as a whole, to ensure that the local disclosure is not misinterpreted by the market.
1.5.5 Future considerations and recommendations
The HKMA has issued a consultation paper to require limited financial disclosure by foreign bank branches. We view this as an important step forward in closing the transparency gap that presently exists. An information sub-group established by the Basle Committee on Banking Supervision is also reviewing the issue of public disclosure.
The HKMA should also continue its work on reviewing and updating the disclosure requirements of all authorized institutions, to ensure that they are in line with international and local market developments. In addition, it would be appropriate for the HKMA to take an active role in promoting understanding among the general public of disclosed financial information (e.g. the difference between non-accrual loans and overdue loans).
1.6 Depositor protection