Banking and Finance Industry in Hong Kong Tsoi Yat Fei Cheung Kwok Tung Mok Ka Yan

Introduction  B&F is one of HK’s “pillar” industries  Its GDP’s contribution increased from 10% in 1997 to 16% in 2006  Central Govt stated repeatedly supporting HK’s status as an “International Financial Centre”

 In 2007  68 of World’s top 100 banks operating in HK.  A total of 258 foreign owned fin institutions operating in HK.  World’s 15th largest banking centre in terms of external assets.

 6th largest centre for FX trading  7th stock market in terms of market cap  5th in terms of total equity funds raised  About US$800b under asset management

 HK’s core competence and challenges  a strong cluster of international firms and services providers  strong links with Mainland and SE Asia  free capital flows and highly liquid market  rule of law

Latest developments in banking sector  HK’s banking industry underwent some difficulties since Asian Financial  Crisis in 1998, with contracting loan portfolio and rising bad debts. But  banking structure has remained stable. Average capital adequacy ratio of  banks was 28% in 2Q 2004, much higher than minimum requirement of about 10%.

 HK’s banking industry underwent some difficulties since Asian Financial  Crisis in 1998, with contracting loan portfolio and rising bad debts. But  banking structure has remained stable. Average capital adequacy ratio of  banks was 28% in 2Q 2004, much higher than minimum requirement of about 10%.

 Banking rebounded significantly in 2004 and 2007 was a very profitable year.Profits for HSBC’s Asia ‐ Pacific operation increased sharply by 53% in 2007 to HK$13.3b.  2008 was the worse year for banking and finance globally, given subprime debacle and meltdown of international investment banking industry. Global investment banking collapsed.

 For example, HSBC needed to provide US$10b bad ‐ debt provisions in 1 st half of Total profits declined by 29% and HK’s profit declined by 8%.  Losses spread from developed markets to developing markets

Major structural features of banking industry  A 3 tier system: 142 commercial banks, 29 restricted licensed investment banks and 29 DTCs by end ‐ 2007  Govt tightened regulatory requirements: to improve stability of banking sector; # of fin institutions declined sharply after Asian fincrisis; banks from 185 in 1995 to 133 in 2005, DTCs from 132 to 29.

 Capital adequacy ratio remained high by international standard  Japan encountered severe recession in 1990s: greatly reduced business operation in HK, # of banks in HK declined from 46 to 11,DTCs from 37 to 3.  US, Mainland and local banks also declined, while Taiwan banks  increased from 5 in 1999 to 17 in 2007.

 Total banking assets were HK$10,400b, 16 % by Mainland banks, 9% US, 6% Japan, 30% European  Total banking assets declined from HK$8,400b in 1997 to HK$6,000b in 2002, down by 29%; mainly due to contraction of Japanese banks and weak economic activities.

 Between 1994 & 1997, Japanese banks loans accounted for more than 50% of total loans; HK was used as a “Booking Centre” for their regional loans; Japan’s 80% loans were overseas loans.  As for other banks, about 80% loans were used in HK.

 Trends for merger and acquisition intensified in 2000s: e.g. Bank of East Asia purchased First Pacific Bank (2000), DBS purchased Dao Heng Bank (2001), BA (Asia) acquired by a Mainland Bank; because more severe competition, economies of scale, required larger asset size to enter Mainland market

 With declining traditional businesses, banks expanded aggressively into non ‐ interest earning businesses, e.g. wealth management, fund management, insurance, investing in other fin assets. Banks’ new strategy was very successful until collapse of Lehman Minibond & Accumulator in 2nd half of 2008.

 Banking is under restructuring now: (i) more conservative & returning to basics, (ii) declining non interest income, (iii) deteriorating risk profile of borrowers, (iv) restrictive lending and de ‐ leveraging, (v) increasing interest & other fees, (vi) more provisions, (vii) declining returns.

Latest developments of securities industry  Market capitalization increased rapidly from HK$6,700b at end ‐ 2004 to HK$20,700b at end ‐ 2007, mainly due to listing of many large Mainland companies in HK. HK ranked 7th internationally Total banking assets declined from HK$8,400b in 1997 to HK$6,000b in 2002, down by 29%; mainly due to contraction of Japanese banks and weak economic activities.

 In 2008, HSI and share prices of many major listed companies once declined by more than 60%. Share prices of HKEx (0388) dropped from a high of HK$265.6 to HK$49.7. IPO activities contracted sharply in 2008  Derivative warrants became very active in recent years, with largest trading volume globally and a lot of retail interest.

Major structural features of securities industry  There were 1,248 listed companies with 444 Mainland ‐ related (5/2008).Mainland companies accounted for about 57% of market cap, up from 27% in 2000 & about 70% of average daily transactions.

 Between 2003 and 2007, HK ranked within top 5 internationally in terms of fund ‐ raised  Top 10 largest IPOs in the last few years were all Mainland ‐ related companies and 9 of them were financial institutions

 Businesses of large IPOs were concentrated with large investment banks, e.g. BOC Finance, Morgan Stanley, Goldman, Deutsche Bank, Merrill Lynch, HSBC, Citi, etc. Other smaller sponsors involved in smaller IPOs.

 Report on Econ Submit on “China’s 11 Five ‐ year Plan & Development of HK”, Major recommendations for promoting HK’s Banking & Financial Sector:  (i) Explaining to Central Govt ways to better utilize HK’s financial system & position to benefits Mainland’s development

 (ii) HK’s regulatory organizations and fin industry should be actively seeking opportunities to set up regular mechanisms to work closely with relevant departments in Mainland to formulate relevant fin policies & strategies.

 (iii) HK’s regulatory organizations should cooperate closely together with relevant departments in Mainland to explore technical implementation details of various financial policies.

 (iv) HK’s regulatory organizations should cooperate closely together with relevant departments in Mainland to explore technical implementation details of various financial policies.

 (v) Liberalizing restrictions to permit more HK financial companies to operate freely in Mainland.  (vi) Liberalizing Mainland’s investors, companies & fin institutions to “go out”, using HK as a platform.

 (vii) Permitting HK’s fin instruments to be traded in Mainland, particularly those issued by Mainland institutions in HK  (viii) Strengthening HK’s position to manage RMB transactions.  (ix) Enhancing connections of HK & Mainland’s financial infrastructure development

 (x) Encouraging more Mainland institutions using HK’s finmarket for international asset management.  (xi) Enhancing HK’s position as insurance and reinsurance centre.

 Regarding securities market:  (i) Inviting more Mainland companies to be listed in HK, on a sustainable basis.  (ii) Reducing transaction cost in securities market.  (iii) Reviewing securities market’s regulatory framework.

 (iv) Encouraging financial innovations.  (v) Promoting activities of fin intermediaries.  (vi) Providing legal backing to listing rules.

 Regarding FX & Futures Markets:  (i) Developing RMB’s futures and options market.  (ii) Attracting Mainland users to participate in HK market.  (iii) Strengthening regulatory system & mechanism for FX, Futures & Commodities markets.

 (iv) Developing more commodity trading products for HK’s market.  (v) Developing HK’s asset management business.

 (iv) Developing more commodity trading products for HK’s market.  (v) Developing HK’s asset management business.

 Collapse of Lehman Brothers in US resulted in a financial & political crisis in HK. “Lehman Minibond” & Re ‐ regulation for HK:  Over 40,000 investors involved, with more than HK$20b. Some people lost all their savings.

 What are the issues:  (i) structural weakness of the current regulatory system (HKMA, SFC, HKAB)  (ii) unethical business practices of management/individual banking employees  (iii) insufficient investors’ education.

 What are the issues:  (i) structural weakness of the current regulatory system (HKMA, SFC, HKAB)  (ii) unethical business practices of management/individual banking employees  (iii) insufficient investors’ education.

Inquiry question  What are the positions of HK Govt, HKMA, SFC, major political parties? Why are they different?