Internet banking in Hong Kong

1. Internet banking in Hong Kong David Carse Deputy Chief Executive Hong Kong Monetary Authority 7 April 2000

2. 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

3. 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, eg: • over 50% of households have PCs • 80% of households have access to broadband • 55% of the population use mobile phones • Electronic Transactions Ordinance provides legal basis for electronic commerce • recognition of digital signatures and certification authorities

4. The current situation • So far only a few banks have introduced transactional internet banking services • But many 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 provision of payment gateways for electronic commerce

5. 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

6. 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

7. 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 brands are important • 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

8. 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

9. 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 losses due to security breaches where they have not been negligent

10. Banking risks • The internet may heighten the risks inherent in conventional banking, eg: • liquidity risk may increase if 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

11. The role of the HKMA • The HKMA’s 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

12. 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

13. The regulatory framework (2) • Issuers of smart cards also require authorization under the Banking Ordinance • E-lenders, portals and aggregators do not require authorization, but need HKMA’s consent to use a “banking name” • Offshore internet banks should comply with rules on advertisements directed at persons in Hong Kong

14. Virtual banks • Some local banks have already indicated their intention to set up separate virtual banks • HKMA has recently issued draft guidelines 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 • Don’t be blinded by the technology!

15. Key features of our guidelines • 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

16. 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? • Cross-border cooperation with other regulators will become more important • Meanwhile, depositors should beware!

17. 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