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"The HKMA encourages the development of virtual banks"

Author: 
Nigel Morris-Cotterill

Arthur Yuen, Deputy Chief Executive, Hong Kong Monetary Authority, today set out Hong Kong's stall. Is today's statement an indication of success or a note being of not-quite competitive?

Yuen has announced (full statement below) that today is the day when the first of eight virtual banks which were granted licences earlier this year, begins its test phase. Hong Kong has been far more cautious than some of its competitors. Even now, the test is only within the HKMA’s Fintech Supervisory Sandbox with 2,000 test customers. Some other jurisdictions have allowed pretty much anyone who claim their product is "fintech" to set up operations in a "regulation light" sandbox.

For Hong Kong, the appeal is "The mode of operation and service delivery of virtual banks therefore differ greatly from those of conventional banks. For example, virtual banks do not have physical branches and instead deliver all services via the internet; nor do they impose minimum balance requirements or low-balance fees on customers."

That, some would say, should be considered a point of enhanced risk. But internet-only banks aren't new. They've been around since the mid 1990s. And a worryingly high percentage of them have been fraudulent or have been vehicles for financial crime of one sort or another. Some have been almost exclusively used by criminals for money laundering and/or tax evasion.

Long before HSBC finally managed to get approval to buy the UK's Midland Bank, Midland was experimenting with branches populated only by machines. In the mid 1990s, Natwest Bank led an electronic wallet system called Mondex. By the early 2000s, one could buy a complete "bank in a box" (a name later trademarked by someone for something different) which was everything, except a licence, to run a bank from - wait for this - a Pentium PC with 2 MB Ram and a 100Mb hard disk. For several years, the phone in your pocket has been more powerful than that. Licences were not hard to come by - again, in the 1990s, a banking licence in one of the more dodgy offshore centres cost USD10,000 including a limited licence (only foreign customers) and a bank account that would operate via the correspondent banking network.

That is absolutely not what HK is planning. It is also why HK is taking things slowly. "The HKMA has put in place a number of regulatory requirements on virtual banks regarding technology risk management and data processing, and requires virtual banks to obtain verification of their compliance by an independent third party. In the past few months, much work had been done on internal testing and preparations, as well as contingency plans for potential operational risks on the part of the virtual banks. While the groundwork has been meticulous, it may be unavoidable that some teething issues arise."

But Yuen is playing up the novelty angle: "a virtual bank is a brand new institution operating in a brand new way amid the ever-changing challenges of the real world." The thing is that it isn't. Or it shouldn't be. There should be no difference in the way that regulators treat banks with no branches than they treat banks with branches. It can even be argued that they are in fact merely replicating the on-line services already offered by banks. The entire concept of branch-less banking has long been a feature of banking in the UK - Midland (again) with First Direct and the Cooperative Bank (Smile) both launched branch-less sister banks. Smile was formed in 1999. That was at the time that Lloyds Bank was advanced with plans to convert branches to sales offices and centralise banking operations.

It's important, then, to realise that, as a world, we are far, far away from anything new in terms of what the new entrants will do. It is the "how" that is, on the face of it, novel. And even then, it's not. It's just glitzy, run from a mobile phone.

And that's why HKMA says something that others do not but should "we will apply the same set of supervisory principles to conventional and virtual banks alike and endeavour to ensure the robustness of virtual banks’ operations."

But remember this: when the first eight licences were announced, the HKMA said that it had had a significant number of applications many of which had been rejected because they couldn't even fill in the forms properly.

Also, there is also something else to consider: the most recent development in relation to virtual banking has been in the parallel universe of cryto-banking. There, over the teething period, there have been hard-disks thrown in the dustbins losing all wealth stored on them, hacking, cracking, lost data, stolen assets.... that universe is parallel but, even with HKMA's careful attention, it's not in a galaxy far, far away.

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Full statement

Ever since the HKMA granted licences to eight virtual banks in the first half of the year, many have been wondering when these new members of the banking industry will commence business. We are delighted to note that the first virtual bank has started its trial run today in the HKMA’s Fintech Supervisory Sandbox, thanks to the diligent efforts of various parties. This not only suggests that Hong Kong banking customers will soon be able to experience more innovative banking services, but also marks a major milestone in the development of Hong Kong’s banking industry. Let me take this opportunity to share with you the main features and future development of virtual banking.

The market is looking forward to the rollout of the eight virtual banks. What are the main differences between virtual and conventional banks? What can the public expect to see?

The HKMA encourages the development of virtual banks, as it can help promote financial innovation, enhance customer experience and facilitate financial inclusion. The mode of operation and service delivery of virtual banks therefore differ greatly from those of conventional banks. For example, virtual banks do not have physical branches and instead deliver all services via the internet; nor do they impose minimum balance requirements or low-balance fees on customers.

Retail customers and small and medium-sized enterprises are the target customers of virtual banks. To start off, the virtual banks plan to provide basic banking services such as deposits, loans and inter-bank transfers. We believe that as virtual banks gain a better understanding of their customers’ preferences and habits over time, they will leverage financial technologies to offer more personalised products and services, and a new user experience to customers.

What do the public need to be alert to when using virtual banking services?

While both virtual banks and conventional banks are obliged to handle customers’ information properly as required by the HKMA, members of the public should still exercise due care when using digital banking services and safeguard their own personal information. Virtual bank users should keep their account passwords safe and change passwords regularly. They should never log in to their internet bank accounts via an unknown Wi-Fi service or a public computer. It would also be wise for users to pay attention to notification messages received from their banks via SMS, and to contact their banks immediately if they suspect that their personal details have been stolen.

The HKMA has put in place a number of regulatory requirements on virtual banks regarding technology risk management and data processing, and requires virtual banks to obtain verification of their compliance by an independent third party. In the past few months, much work had been done on internal testing and preparations, as well as contingency plans for potential operational risks on the part of the virtual banks. While the groundwork has been meticulous, it may be unavoidable that some teething issues arise. After all, a virtual bank is a brand new institution operating in a brand new way amid the ever-changing challenges of the real world. Should any unexpected issues arise, the virtual bank concerned should of course address them quickly and properly. At the same time, we also hope the public can demonstrate understanding.

During the trial run of a virtual bank, the HKMA will closely monitor its operation and communicate with the bank which will make adjustments when necessary. If the outcome of the trial run is satisfactory and the HKMA is satisfied that the virtual bank meets all the relevant regulatory requirements, the virtual bank will be allowed to formally launch its business. As set out in the HKMA’s Guideline on Authorization of Virtual Banks, we will apply the same set of supervisory principles to conventional and virtual banks alike, and endeavour to ensure the robustness of virtual banks’ operations.

Is there a blueprint for the future development of virtual banks?

The market has shown keen interest in virtual banks. Since the eight virtual bank licensees were announced, quite a few other institutions have approached the HKMA and expressed an interest in applying for a new licence, suggesting strong market confidence in the industry’s prospects. We will monitor the operations of the virtual banks, user response, the level of market acceptance and the impact on the banking system before carefully planning the next steps for further development of the virtual banking industry.

It is worth noting that the first virtual bank which rolled out its services today has announced the specific arrangements for its trial run, involving some 2,000 interested members of the public as the first batch of users. We believe that the bank will carefully review and address feedback from the participants in order to improve its products and services, and get better prepared for its formal launch.

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