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“The Future of Banking in Hong Kong - the Impact and Implications of Internet Banking”. David Carse Deputy Chief Executive Hong Kong Monetary Authority 14 June 2000. The “Age of the Internet”. Ignore the hype about dot.com companies
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“The Future of Banking in Hong Kong - the Impact and Implications of Internet Banking” David Carse Deputy Chief Executive Hong Kong Monetary Authority 14 June 2000
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
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: • over 50% of households have PCs • 80% of households have access to broadband • 55% of the population use mobile phones • about 30% of the population are internet users • Electronic Transactions Ordinance provides legal basis for electronic commerce • recognition of digital signatures and certification authorities
The current situation • So far about 14 banks have introduced transactional internet banking services either directly or using the JETCO virtual ATM service • 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 bill presentment, payment services and trade finance
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
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
The nature of the dilemma “For many institutions the Internet is a double bind. Embrace it, and you may still find yourself losing business, or at least seeing profit margins dwindle. But ignoring it could be terminal.” The Economist
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 customer base and brands are important • “online banking from a company that’s been around longer than a week” (American Express) • 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
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
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 direct losses due to security breaches etc unless they have acted negligently or fraudulently
Banking risks • The internet may heighten the risks inherent in conventional banking, eg: • liquidity risk may increase if depositor loyalty is reduced and/or 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
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
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
The regulatory framework (2) • Issuers of smart cards also require authorization under the Banking Ordinance • E-lenders, portals and aggregators need HKMA’s consent to use a “banking name” • Offshore internet banks should comply with rules on advertisements directed at persons in Hong Kong
Virtual banks • Some local banks have already indicated their intention to set up separate virtual banks • HKMA has recently issued a Guideline 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!
Key features of our Guideline • 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
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? • what is the legal position of ISPs who transmit advertisements? • Cross-border cooperation with other regulators will become more important • Meanwhile, depositors should beware!
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