Hong Kong has opted for a minimum assets size requirement of US$16billion of the whole banking group for foreign banks, effectively blocking full participation in the banking sector by smaller foreign banks, even if they are comparatively well capitalised.
The primary benefits of this approach have been that it has still allowed access by major international banks, which have contributed significantly to Hong Kong’s status as an international financial centre. It is also a transparent measure that foreign financial institutions must meet in order to enter the Hong Kong market as banks. At the same time, smaller international institutions have a means of entry as RLBs or DTCs.
Entry criteria based on asset size presume that large balance sheets are automatically equated with sound and prudently managed institutions. This presumption is sometimes wrong, as indicated by the many large bank failures which have occurred in recent years as markets have opened up to competition. When wrong, the presumption is very risky to banking systems and underlying monetary stability, evident today in Japan, and apparent in the US in the 1980s. The other authorization criteria, such as adequacy of financial resources, adequacy of home supervision and requirement for adequate internal controls do however address this issue and, in licensing banks, the HKMA does ensure that new market entrants are sound and prudently managed.
We consider that the assets size criterion for foreign branches should be maintained.
This criteria does not appear to have deterred any market entrants and provides a means for the HKMA to filter out smaller applicants who may not necessarily require a full banking licence. Smaller banks, which do not meet the asset size criterion, and those from countries where the adequacy of home supervision may be difficult to assess in practice, have the alternative to enter the market as RLBs or DTCs.
In addition, the current override, based on a broad consideration of Hong Kong’s interests, allows the HKMA to permit broader access by smaller banks of a high quality, when this is considered beneficial to the sector as a whole. Therefore, we do not envisage any need for change in this regard.
Capital requirements for locally incorporated banks
Locally incorporated institutions’ minimum capital requirements have not been updated since 1989. In this period, cumulative inflation has been approximately 95% and it
would therefore be appropriate to reconsider the level of minimum capital for local authorized institutions.
In addition, the capital requirement for locally incorporated banks appears to be out of line with the minimum asset requirement. This is important because banks should maintain adequate capital to support the assets on their balance sheets (as required by the minimum CAR requirements). However, the capital-to-asset ratio of most local banks indicates that, in practice, a new local bank would need to have substantially higher initial capital in order to meet minimum CAR requirements. The assets requirements may be met by the new institution but only by holding these assets in low risk weighted categories (e.g. cash). Therefore a new bank would not be able to take on a normal market-based balance sheet structure, which could limit its operations.
We recommend that the HKMA consider increasing the minimum capital requirements to take into account inflation and to bring into line the minimum capital and minimum assets criteria for locally incorporated banks. Based on inflationary effects alone, the amount of minimum capital should be approximately HK$300million.
We would also recommend that the minimum capital requirements for RLBs and DTCs be reviewed at the same time, although this may need to be performed in the context of any changes to the three-tier system.
Foreign branch capital
Foreign branch capital or an equivalent is required by a number of countries for several reasons. However, in the context of Hong Kong, the need for a form of branch capital would appear to relate principally to the need to strengthen depositor protection. In the context of the current liquidation laws, imposing a branch capital requirement would not significantly improve the current depositor protection scheme. Additionally, it is likely that such a requirement would reduce the attractiveness of Hong Kong as an international financial centre. Further, the absence of a branch capital requirement would not be unique to Hong Kong as there are a considerable number of countries in the same situation (e.g. most European countries have no branch capital requirements).
Therefore, we do not see any need for the current situation to be changed.
Time period and association with Hong Kong
There does not appear to be a significant need or desire on the part of foreign banks which are qualified to enter as fully licensed banks to change the form of entry per se.
Allowing foreign banks to enter the market as locally incorporated banks (rather than branch banks) does not appear likely to have a significant impact on the attractiveness of Hong Kong to potential overseas participants. In addition, the evidence indicates that it is doubtful whether many foreign banks would choose this route in preference to branch status due to the flexibility accorded to them as a branch.
However, these criteria appear over burdensome and unnecessarily restrictive in determining the qualifications of new market entrants, such as any RLB or DTC,
wishing to fully participate in the market. This has the effect of reducing the level of competition.
We recommend that the HKMA should consider reducing the time period to three years, which should be sufficient for institutions to gain a clear understanding of the local market and for the HKMA to assess management skills and systems to operate in the local banking sector21.
The requirement to be closely associated with Hong Kong no longer appears to be relevant in view of globalisation trends, the fact that the local banking sector is already well established and it is inconsistent with the ability of a foreign bank to purchase a local bank (i.e. a foreign bank may not set up its own subsidiary but may purchase one nevertheless). We therefore recommend that the HKMA consider relaxing this criterion.
Relaxing the one-building condition in itself would provide more flexibility to new and existing foreign participants. Therefore the timing of change to these criteria should be reviewed only after the impact of relaxing the one-building condition has been fully ascertained.
Ownership
As regards the ownership criteria, we consider that this acts as a very strong control over ownership of deposit taking institutions and helps ensure that owners are fit and proper. Since non-banks are able to enter the market through joint ventures and as minority shareholders, we do not see any need for this situation to be changed.
21 This would also imply that, those foreign banks which have operated in branch form for the same period, should also be given the option of local incorporation.
1.5 Financial disclosure