A Skeptical Look at HK’s 8 New Virtual Banks*
It’s too early to write the obituaries of brick-n-mortar banks
Kudos to the Hong Kong Monetary Authority. 8 new virtual banking licenses announced in the span of 4 months — that is unprecedented. For an industry infamous for its opacity, and lack of new entrants, to completely change the dynamics of HK’s financial universe is a very bold move — and it must be lauded. Never mind that the first guidance on authorisation of virtual banks (VBs) was way back in 2000 — let us rejoice where we are today.
To put this change into perspective — this represents just the second increase in HK’s locally incorporated licensed banks in 15 years — a timeframe that has seen massive bank consolidation (i.e. acquisitions) due to slowing loan growth and reduced bottom-line. In the past few years, Singaporean and Chinese banking groups have expanded operations onshore, buying legacy HK banks to offer financial products to the SMEs and the retail segment.
However, within a span of 4 months, HKMA has changed the rules of the game, with the new batch of 8 virtual banks taking us back to the heydays of 2001 — when 30 locally incorporated banks used to jostle for growth. These are exciting times indeed.
HK’s banking system at a glance
However, before we move further, let me share some information and statistics on HK’s banking system.
- 96% of HK’s population of 7.5 million has a bank account, with better credit history than their OECD peers, including lower borrowing statistics from financial institutions (8.2% vs. 18.4% for OECD) and less card dependence (70% vs. 80% for OECD).
- HK has a three tiered banking model — with 160 fully licensed banks (LB), 8 restricted licensed banks (RLB) and 16 deposit taking companies (DTC) providing customers loans & advances and financing trade. Of the 160 LBs, 30 are incorporated in HK (including the 8 virtual banks), and 130 are incorporated outside HK.
- Licensed Banks (LB) dominate HK’s banking landscape — making up 99.3% of total loans as of 31 March 2019. The chart on the left shows the massive growth over the past 36 years — from 62% in 1983. However, scratching under the surface, one finds a huge gulf in the reach and coverage of these licensed banks.
- Of all the LBs, just three names — HSBC (incl. subsidiary Hang Seng Bank), Standard Chartered, and Bank of China (HK Holdings) — control 2/3rd of the retail banking, 3/4th of the mortgage market, 3/4th of the credit card business, and half of the deposits. To say, these three note-issuing banks run HK’s financial coffers would not be an understatement.
- Retail banking is twice as profitable in HK viz-a-viz corporate banking, explaining why 130 international organisations are registered as licensed banks within the city state. There are plenty of reasons for that, with good customer repaying ability (or low risk of default) a boon to banks, allowing them to cross-sell more products, eg, auto loans for mortgage customers, or tax loans for existing personal loans customers.
The New Entrants
Given this landscape, it was intriguing when HKMA invited applicants for virtual banks with a two pronged goal — “to promote fintech and innovation in Hong Kong to offer a new kind of customer experience” and “to promote financial inclusion to target retail segments and SMEs”. While the former is an obvious area of expertise for FinTech-oriented virtual banks (VBs), the latter seems a bit harder to understand, or breach, in this author’s opinion, given the hold of licensed banks on SMEs and retail banking.
Nonetheless, below are the Fab 8 that will look to challenge the domination of the 22 pre-existing banking behemoths.
- Ant SME Services (shareholders: Ant Financial)
- Infinium Limited (Tencent, ICBC Asia, Hillhouse Capital and HKEX)
- Insight Fintech (AMTD and Xiaomi)
- Ping An OneConnect (Ping An Group)
- Livi (Bank of China HK, JD Digits, and Jardines)
- SC Digital Solutions (Standard Chartered Bank, HKT, PCCW, and Ctrip)
- WeLab Digital (WeLab)
- Zhong An Virtual Finance (ZhongAn Online and Sinolink)
Many of these are collaborations between financial firms and technology firms, eg, Livi, SC Digital and Infinium, while others firms are going solo (eg, PingAn, Insight, Ant SME and WeLab). Though none of these VBs have announced their business models yet, this author feels a sense of cautious optimism about this whole scenario.
First, the Optimism
1. Let there will be innovation
If you are a customer, it is a time to rejoice. The next few months are likely to see new banks lining up to offer customers easier account opening, cash giveaways to restaurants and supermarkets, probably new credit card deals with other startups or more miles (and cash back), and maybe more favourable credit lines to acquire assets (houses/cars etc.)
In short, happy days!
This innovation might not be restricted to the VBs alone — as incumbent banks will also compete to hold on to their customer base. This will necessitate spending on their digital banking prowess (‘digital transformation’ for those into buzzwords)— to compete with the new entrants. In essence, HK’s 7 million+ bank customers can expect the next 12–24 months to see improvement in customer experience, and hopefully a host of new goodies. And that, is a huge positive.
2. More hiring
Branch-based retail banking has been notoriously constrained by high staff costs, even though banks’ profit margins have outweighed costs (especially for the bigger banks). However, as part of a new norm, one can expect many medium-to-senior level retail bankers will be joining the new VBs — setting up their middle and back-end operations (including KYC / Compliance / AML practices), helping with product expertise and client base.
Some, like WeLab, have publicly announced plans to hire 100 more people in 12 months, while SC Digital (65% owned by Standard Chartered) also plans to hire 40 more bankers. Interestingly, hiring could go the other way as well, as established banks spruce up their digital banking.
This hiring spree will depend a lot on banks’ focus — from product (eg, SME, or retail banking) or technology (eg, FinTech, Digital transformation) to geography (eg, Greater Bay Area).
With a decade of lay-offs behind us, this offers an unexpected bright spot for HK’s financial landscape, and its FinTech-savvy university graduates.
3. The opportunity set
Despite averaging about 2.5 mobile phones per capita, Hong Kong ranks very low in daily mobile banking penetration of 14% vs. 20% for global average. While some of it is due to demographics and mindset (more on that later), other reasons have to do with the poor mobile banking experiences thrust on the customers.
That said, this author has noted a significant improvement in HK banks’ app and mobile user experience over the past two years, especially for HSBC, DBS and Standard Chartered, all of whom have invested heavily to offer on-demand banking solutions to its demanding customer-base.
That said, branchless banking remains quite a challenge in HK. While digital and branchless banking is common in many parts of the world, HK remains a serious laggard due to legacy issues, customer demand for high-touch banking and an over-dependence on paper-based workflow. Even a behemoth like JP Morgan mentioned in their annual investor day report (in February 2019) it has the ability to shut down 75% of its US branches in 5 years or keep them open for decades. But, HK banks have not shown that sort of flexibility.
That is about to change.
With VBs offering a new business model to run operations and service customers, one can expect brick-n-mortar banks to follow suit (albeit in a few years), and hopefully, utilise their advanced digital banking prowess to reduce costs of running a branch, without sacrificing on service quality.
4. Better customer understanding
One of the first questions I used to ask bank CEOs (in my avatar as a banks research analyst) was, “How much do you know your customer?”, and they would often answer in numbers — we have x% product cross-selling rate, or we help y% of businesses in Pearl River Delta, etc . Many of these were top-down data sets, with clear limitations on how much they actually ‘knew’ their customers.
To a mildly tech-enabled banks analyst this seemed like a missed opportunity! Established banks’ analytics arms have so much information they can concur from just one part of their customers’ lives — finances. Think about it, what information can a financial report tell about your life ?
- When and where you eat/drink/shop,
- How much you spend on travel, clothes, necessities and education,
- When do you get your salary and how it track against peers,
- What are your recurring expenditures say on school tuition, rents, travel etc.
If brick-n-mortar banks wanted, or were allowed to (by regulators), or had the right technology to do it, they could have harnessed the power of ‘big data’ before the foray of tech firms in the space! Think of all the great products a bank could have created for its customers — differentiated service for differentiated pricing— at the click of a button!
And that is the opportunity that VBs will try to explore, at least the tech-enabled ones, eg, Ant SME and Infinium. These companies know their customers inside-out, from their habits, to their movements and behaviour patterns. That is a massive boon for VBs that can harness knowledge of customers’ lifestyles — from social media, P2P payment patterns and taxi or supermarket spendings — while cross-selling financial products.
In essence, adding a financial engine on top of all this data set is a gold mine of opportunity. And curiously, this opportunity is welcomed by both sides of the market, with consumers happy to bank with tech firms, even though their privacy is usually tossed out of the window.
However, for all these positives, it might be too soon to write the obituaries of brick-n-mortar banking systems. Why you ask? Read on below, why this author feels they have more than a fighting chance in this race.
And, then the Caution
1. Business model differentiator
Maybe this is jumping the gun, as none of the VBs have announced their business models or focus areas publicly — but 8 new banks seems a massively high number when 96% of HK’s population is banked. Other than the feng shui nature of it, 8 new licenses seems about 5–6 banks too many, especially as this takes the total locally incorporated licensed banks to the highest number since 2001! Remember how we ended up from 31 banks to 22? Consolidation. Why? Because, there is just not enough product innovation to justify so many banks.
As a former banks research analyst, I am left scratching my head to answer the following questions:
What will be the differentiators of these virtual banks, other than technological innovation?
What ‘new and innovative’ products will they offer that have not been offered to retail and SME customers yet?
What kind of financial inclusion does the HKMA expect? Is it the race to get the 4% banked?
- If the VBs’ value proposition is access to the greater bay area, then they have stiff competition from the incumbent banks, as some of them have been focussing on that segment since 2016, eg, credit cards by ICBC, and banking services by Bank of China (HK) and HSBC.
- If VBs can support the entrepreneurial spirit of other FinTech firms or tech-focussed SMEs — that could be a great initiative — though, how much it contributes to recurring loan growth (and bottom-line growth) will be worth seeing.
In my humble opinion, technology can only be an enabler — and VBs will have a clear advantage as they are nimble, more cost effective and can rely on previous operations (whether financial or transactional) to drive up customer numbers. But, they will have to use all these advantages with the right product offering if they want to have a long term successful business model.
Talking of business models — there are two clear types of VBs here — (a) the collaborators (eg, SC Digital, Livi and the like) and (b) the sole operators (WeLab or Ant SME or Ping An etc.). The former group will be reliant on bringing different expertise together (product / tech), but how easily that can be achieved is an open question! There are some senior bankers from the traditional world who are already sceptical about that, echoing a sentiment of ‘too many cooks spoil the broth’!
According to this author, having a solid focus helps in delivering efficiency gains, even if that comes at the prospect of a measured growth in customer acquisition. In that sense, the latter group, could be better placed.
2. So product offerings, anyone?
There is widespread excitement amongst FinTech aficionados and customers at the prospect of technology firms, especially Ant Financial and Tencent, getting involved with banking. After making a serious dent in the world of P2P payments, this seems a natural progression.
So what kind of products?
There is widespread belief that the first products to be offered will be the mundane/tried-n-tested — savings accounts, credit cards, personal loans and travel insurance — none fancy, but add $$ to the bottom-line — assuming you manage to find your customers.
This author believes it is highly unlikely that VBs will become full-fetched banking behemoths like an HSBC — offering all products under one (mobile) roof. Instead, VBs might be better served to find a niche product, and grab market share, before adding other products.
Creating new products or better offerings will differentiate VBs from the incumbent banks.
Sure enough, customer experience improvement is a given — that is the level of expectation priced in — but, only technological improvements will not be novelty enough. What this customer (and surely many others) are interested to know, will you offer new and innovative products without requiring 15 pages of documents and 45 minutes of my time?
Eg, can you create technological solution that could track supply chains across countries close to real-time, and thus price working capital loans better for ecommerce firms? If yes, you have new customers to sign, virtual banks.
Moreover, when rubber hits the road, can you translate that innovation into bottom-line growth? Generating returns in an already-packed market just by virtue of being a Tencent is not guaranteed. VBs will need to enhance operational efficiencies into offering bespoke products that break down the rigidness associated with incumbent banks. And that, is a very hard task.
3. Banking is hard business
Without stating the obvious, running a bank is a hard business. Ask any senior executive working at a bank, and they will confess to a myriad of problems that keep them up at night — customers, products, technology & innovation, competitors etc.
To make matters worse, banks’ stakeholder chart is unenviable:
- Customers (for loans and deposits)
- Clients (for various products)
- Employees (obviously!)
- Bondholders & Shareholders
- Government (for taxes)
- Regulators (HKMA, we are looking at you)
That is a lot of different parties that a bank’s senior management is answerable to — in some way or another. Moreover, this mesh of stakeholders creates operating a bank a very complex proposition.
Senior management’s tasks are made harder by the Basel 3 guidelines that have been applied post the financial crisis. Though it makes a bank safer, many Basel 3 guidelines are incredibly punitive to their profit growth as they curtail ‘excessive’ risk taking. This means banks are under constant scrutiny from their stakeholders, and that has a negative impact on innovation.
This is not going to be a ‘pure tech play’ where network effects and awesome customer experience can solve problems. VBs will have to take all their stakeholders along, and that usually means a slow ride — hopefully, to the top. It also means multiple approvals required for new products, something many tech firms are not used to in their open source idea generating, and winner-takes-all world.
4. Demographics and mindset changes
Despite being one of the world’s premier financial centre, Hong Kong has a remarkably narrow innovation bent — and a lot of it has to do with demographics, mindsets and behaviours.
- The median population age in Hong Kong is 43 years (as of 2014), implying 20+ years of banking the same way — in person at branches, through relationship managers and calls to bankers.
- Though this group has been using mobile and digital banking for a good part of 7–8 years now, there is still hesitance on trusting technology completely — owing to a conservative mentality! And once you have built trust with a bank, you rarely leave.
- So, realistically speaking:
Can VBs convince customers to open a new bank account with their bank? Sure.
But will these customers move their entire business to a new bank? That is slightly harder to believe.
- While many of VBs will likely focus on ‘millennials’ to drive up growth, that segment is also hard to capture. A survey of millennials, showed they want a combination of high technology integration and high touch experience — which might be hard to replicate in a branchless model. (High touch means on-demand bank staff interaction.)
Another example of mindset lock-in evident in HK is through Hang Seng Bank (a 66% subsidiary of HSBC). Though none of its products (loans / deposits / cards) are priced lowest in the market or considered innovative by design, it has differentiated itself through a unique marketing strategy. Hang Seng is known to tap Hongkongers while they are still in universities, and are normally rejected by other banks. This gives Hang Seng bank customers a sense of loyalty often seen missing with financial institutions. Will some of these virtual banks find a way to challenge that loyalty in the long run? Yes, but, they will have to use their best marketing capability, and even then it will likely be a few years before the tide shifts materially.
5. Process. Process. Process.
While these tech firms might have grand visions of bringing innovation to their customers, they might have to factor in some archaic and back-breaking processes. And that is not the fault of incumbent banks — but the regulators.
A lot of financial processes are still notoriously and excruciatingly paper-based — from on-boarding customers to selling them different products. Moreover, all customer records are mandated to be stored for 7 years (in digital / microfilm / paper form).
These are just some of the challenges VBs will have to overcome — in an industry where ‘safety’ takes precedence over ‘speed’. Unfortunately, in many cases, ‘safety’ means more humans added to the process. If VBs can find alternative (read, tech) solutions to overcome bureaucratic processes, then they are definitely at an advantage!
- Will VBs need approval from regulators before rolling out new products? Probably!
- Will VBs completely eliminate paper-based processes over the next 5 years? Unlikely!
- Will VBs be required to send paper-based declaration forms (eg, FATCA for US tax declaration) to your registered address? Sigh. Yes!
Unfortunately, even tech firms’ previous financial avatars — eg, Blue Insurance (from Tencent) — have not been able to remove paper processes. As DigFin reported, Blue had a glossy front-end of a mobile app supported by paper-based and human monitored claims process.
The key question is: How much leeway will regulators provide to these new virtual banks?
If regulators relax rules and rigidity on process documentation, then customers might truly be able to enjoy a virtual banking experience! And, thankfully, that leeway will extend to virtual, as well as traditional incumbent banks.
But, the early indications are not so benign. This from the HKMA announcement:
Virtual banks will be subject to the same set of supervisory principles and key requirements applicable to conventional banks, although some of the requirements will need to be appropriately adapted to suit the business models of virtual banks.
Final word: A lot to do for the virtual banks
From a customer’s perspective, the more competition for my $$, the better. Also, with 8 new online-only banks, one would expect a natural improvement in the experience of dealing with financial institutions, if not, in getting all products under one roof.
However, to expect brick-n-mortar banks to ride into oblivion is a drastic underestimation of how tough banking really is. In my humble opinion, none of these VBs will become full-scale multi-product banking behemoths of the calibre of Citibank, HSBC or Standard Chartered — at least not in the near term.
Instead, the 8 new VBs will put in the hard yards to find their niche, and hope to convince customers that their technology, their UI/UX and their products are more innovative and worth trying. However, their success will also depend on external factors, like mindset changes from a largely risk averse population with no dearth of banking relationships, and regulators, who are very critical to this process.
The below is a fitting ending from Norman Chan, Chief Executive of HKMA:
Financial inclusion is easier said than done, requiring the concerted efforts of the regulatory authorities and the banking industry, as well as the cooperation of the customers. I am very pleased to see that recently some local and international banks have actively expanded their SME businesses in Hong Kong, providing greater convenience from account opening to business support. I believe the general public and enterprises can now find banks that will suit their needs and provide thoughtful services.