Hong Kong: Law of Offshore
The Banking Ordinance is the basis of the legal framework governing the banking sector. The Bank Advisory Committee, which is composed of members of public-sector and private financial institutions, advises government authorities on issues concerning the Banking Ordinance.
The Banking Ordinance was amended in 1986 to authorize the Commissioner of Banking to regulate the banking sector, set minimum capital standards, and limit loans to customers and bank employees. Amendments to the Ordinance in 1995 gave the HKMA broader powers, including responsibility for all matters pertaining to the authorization of banks. The HKMA can suspend or revoke the license of a bank found to be in violation of regulations designed to protect the safety and soundness of the financial system. It is also authorized, after consultation with the Financial Secretary of Hong Kong, to take over a financial institution that is unable to make payments or if it is deemed in the public interest to take control of the firm.
There is a three-tier banking system of "authorized institutions" in Hong Kong: licensed banks, restricted-license banks, or deposit-taking companies. Only licensed banks are permitted to accept deposits of any size and maturity and to offer checking and savings accounts. They effectively function as commercial banks. Restricted-license banks are limited to accepting deposits of more than HKD500,000 and thus offer investment banking services. Deposit-taking companies are only authorized to accept deposits over HKD100,000 that have an initial maturity of at least three months. Hong Kong adheres to the Basle principles for bank supervision.
The approach is one of ongoing supervision and includes on-site reviews of operations and financial records and off-site reviews of financial statements and reports. Banks are required to be incorporated and publish detailed audit reports as well as monthly returns showing assets and liabilities. In addition to information on their balance sheet and quality of assets, banks are required to disclose inner reserves, realized profits, and net assets. Authorities meet annually with internal and external auditors to review each institutions audit and determine if the institution is in compliance with prudential standards and the Banking Ordinance. The Banking Ordinance, in turn, provides a legal basis for enforcing the Basle standards. Violation of the Banking Ordinance is punishable by fines, imprisonment, or both.
The Banking Ordinance restricts the use of the word "bank" to those institutions that are either licensed or restricted-license banks. In the latter case, the word "bank" must be accompanied by either "merchant" or "investment." Only a "fit and proper person" can be issued a banking license, and there exist controls regarding the ownership and management of an authorized financial institution. An authorized institution is required to inform the HKMA if it makes changes to any documents that outline the institutions procedures. Approval is also required before there can be any changes in a banks ownership.
The Banking Ordinance also sets forth minimum capital requirements for authorized institutions. Locally incorporated banks must have paid-in capital equal to US$388 million and net assets of US$518 million dollars for authorization to operate a licensed bank. Applicants for a restricted-license bank must have paid-in capital equal to US$12.8 million.
Authorized institutions are not permitted to lend more than 25% of their capital base to a single customer or group of related customers, nor are they allowed to hold more than 25% of shares in other companies. No more than 10% of an authorized institutions capital base may be used for unsecured loans.
The HKMA adopted BIS capital-adequacy guidelines in 1989. The minimum standard according to BIS recommendations is a capital-adequacy ratio of 8 percent. The national requirement in Hong Kong is also 8%, although some banks are required to maintain 12% and some nonbanks at least 16%. The actual risk-based capital-adequacy ratio at the end of 1995 was 17.5%. In December 1996, the HKMA implemented reporting requirements that direct banks to address market risk in calculating their capital-adequacy ratio.
New Banking (Capital) Rules came into effect in January, 2007, and are the implementing Rules for Basel II, the new international standard for banks' capital adequacy.
They set out in detail the different approaches that can be adopted for calculating the capital charge for credit, market and operational risks.
They were issued under a new rule-making power provided under the Banking (Amendment) Ordinance 2005, and replaced the previous regulatory capital regime set out in the third schedule to the Banking Ordinance. This was to be followed by a consultation on the Banking (Disclosure) Rules.
In September 2010, HKMA deputy chief executive Arthur Yuen Kwok-hang suggested that Hong Kong's banks will have few problems complying with the latest changes to international capital adequacy rules under Basel III. He said that local banks' capital ratios are already well above existing standards, with capital adequacy ratios standing at 15.7% in June 2010.
Under Basel III banks will have to maintain capital adequacy ratios at 8%, but tier 1 capital requirement, which includes common equity and other qualifying financial instruments based on stricter criteria, will increase from 4% to 6% from January 1, 2013 to January 1, 2015. Banks will be required to hold a capital conservation buffer of 2.5% to withstand future periods of stress bringing the total common equity requirements to 7%. The buffer requirement will be phased in from January 1, 2016 to January 1, 2019.
Foreign-owned commercial banks can enter the Hong Kong banking industry by establishing a branch or by acquiring ownership of a local bank. Foreign-owned firms must apply for a license to enter the financial services market. License approval is subject to four criteria: foreign-owned firms must (1) satisfy the minimum net asset requirement, (2) be incorporated in a country that applies the Basle principles for bank supervision, (3) have approval from their home country to operate a branch in Hong Kong, and (4) come from a country that offers reciprocal access to Hong Kong banks. Of the 224 authorised institutions in Hong Kong in 2004, 197 were beneficially owned by interests from over 30 countries. In addition, there were 89 local representative offices of overseas banks in Hong Kong.
At the end of June, 2010, there were 146 licensed banks, 24 restricted licence banks and 27 deposit-taking companies in business. These 200 authorised institutions operate a comprehensive network of 1,600 local branches. In addition, there are 70 local representative offices of overseas banks in Hong Kong.
Hong Kong does maintain restrictions on the number of branches that foreign banks are permitted to operate. In 1994, authorities relaxed the one-branch limit for foreign banks, allowing them to open one additional office in a separate building from the location of their main branch; however, the additional office is to be used only for "back office" functions such as processing and settling transactions conducted in the main branch office. Fully licensed banks (commercial banks) are allowed to establish operations in Hong Kong only as a bank branch. Restricted-license banks (investment banks) are permitted to open branches or subsidiaries. Licenses for deposit-taking companies are extended only to locally incorporated subsidiaries.
In the light of China's accession to the WTO, in December 2001 the Hong Kong Monetary Authority reduced the US$16 billion minimum asset requirement for foreign banks, bringing the amount needed down to HKD5 billion, in line with the requirements for local institutions. As well as encouraging foreign financial institutions to put down roots in the SAR, the authorities hope that this move will encourage the mainland to reduce its minimum asset requirements - previously set at US$16 billion - which would make it easier for Hong Kong banks to establish there.
'These proposals would further open up Hong Kong's banking sector to allow a broader range of domestic and international institutions to participate in the Hong Kong markets as full licence banks,' explained the Deputy Chief Executive of the HKMA, David Carse, adding: 'We believe these incentives will help to rationalise the authorisation and market entry system in Hong Kong and will also enhance the status of Hong Kong as an international financial centre.'
Two accounting standards came into force in Hong Kong in January 2005 . Hong Kong Accounting Standards 32 and 39 are detailed and prescriptive in nature, requiring banks to estimate loan provisions based on future cash flows rather than the current guidelines issued by the Hong Kong Monetary Authority, and review the basis for general provisioning.
Most banks hold a general provision of around 1% of total advances, as required by the Hong Kong Monetary Authority. The new standard requires this to be based on an analysis of historical loss experience and may lead to a significant write back of general provisions.
The standards are the Hong Kong Society of Accountants' final step in achieving full convergence with International Financial Reporting Standards. In achieving full compliance Hong Kong banks will be more comparable with their international peers, facilitating easier access to cross border capital markets.
Banking Code of Practice
On December 31, 2008, the Hong Kong Association of Banks and the Deposit-Taking Companies Association (DTCA) jointly announced the launch of a revised Code of Banking Practice (the Code) which will took effect from January 2, 2009. The revised Code has been produced following a comprehensive review of the existing Code by the Code of Banking Practice Committee (CBPC), which has representatives from HKAB, the DTCA and the Hong Kong Monetary Authority.
The main objective of the review was to clarify and enhance the provisions of the Code in the light of recent developments in the banking sector. Among the major improvements are:
- the introduction of a new section to require Authorized Institutions (AIs), which include licensed banks, restricted licence banks and deposit-taking companies to give reasonable notice, normally not less than 2 months, to customers before closing a branch. The notice should be prominently displayed on the branch premises and should contain details of how the AI may continue to provide services to customers and provide contact information in case of enquiries by customers;
- the rewriting of the provisions relating to guarantees and third party securities to make them more reader friendly. These provisions were introduced in 2003 to enhance the protection of guarantors. One of the requirements is that AIs should offer a choice between a limited or unlimited guarantee to any person proposing to give a guarantee or third party security. In the case of an unlimited guarantee, AIs are required to notify the guarantor as soon as reasonably practicable when further facilities are extended to the borrower;
- the updating of the chapter on “stored value cards” to offer more protection to stored value cardholders through various measures, including the provision of channels to check previous transactions and the requirement to reimburse the cardholder as soon as reasonably practicable where a transaction cannot be completed successfully but value has been deducted from the stored value card;
- the enhancement of the provisions relating to security advice for cards and e-banking services to provide more guidance to facilitate compliance by AIs as well as to make it easier for customers to understand what they should, and should not, do in order not to compromise the security of their card and e-banking transactions;
- the expansion of the provision in relation to advertising and promotional materials of AIs to make it clear that where benefits offered are subject to conditions, such conditions should be clearly displayed in the advertisement wherever practicable, or the advertisement should include reference to the means by which further information may be obtained; and
- the expansion of the provision regarding notice on dormant account charges to require AIs to also advise customers of what can be done to avoid such charges or where they can obtain such information.
AIs were expected to take steps to comply with the revised provisions within 6 months from the effective date at the latest. Another 6 months is allowed for compliance with those revised provisions which require system changes.
As a bank regulator, the primary objective of the Hong Kong Monetary Authority (HKMA) in respect of the developments of electronic banking (e-banking) is to ensure that the regulatory framework for e-banking keeps up with the industry and technological developments without stifling innovation.
Since 1997, the HKMA has been issuing a series of circulars to set out its regulatory approach on e-banking services and to provide authorised institutions with recommendations on the risk management for these activities. While institutions do not need to seek formal approval from the HKMA to offer their e-banking services, they should discuss their plans and risk management measures with the HKMA in advance.
Among the issues discussed, the arrangements adopted by institutions to ensure adequate information security for their services are one of the key focuses of the HKMA. While absolute information security does not exist, institutions are expected to implement information security arrangements that are "fit for purpose", i.e. commensurate with the risks associated with the types and amounts of transactions allowed, the electronic delivery channels adopted and the risk management systems of individual institutions.
Furthermore, the HKMA expects senior management of institutions to commission periodic independent assessments of the information security aspects of their e-banking services. The HKMA expects such independent assessments to be carried out by trusted independent experts before launch of the services, and thereafter at least once a year, or whenever there are substantial changes to the risk assessment of the services or major security breaches. To provide further recommendations to the senior management of institutions on information security, the HKMA issued in July 2000 a Guidance Note on Management of Security Risks in Electronic Banking Services.
Internet Advertisements for Deposits
Under the Banking Ordinance, overseas-incorporated institutions (including virtual banks) intending to solicit deposits from members of the public in Hong Kong would not be required to be authorised, provided that the deposits are placed overseas. However, section 92 of the Banking Ordinance makes it an offence for any person, other than an authorised institution, to issue an advertisement or invitation to members of the public in Hong Kong to make a deposit, even if it is made outside Hong Kong, unless the disclosure requirements in the Fifth Schedule to the Banking Ordinance are complied with. They should include a warning in their advertisements that they are not authorised under the Banking Ordinance and hence are not subject to the supervision of the HKMA. The advertisements must also contain certain specified information about the overseas institutions and the deposit scheme being advertised. The objective is to ensure that material facts are available to enable prospective depositors to make their own judgement on whether to place a deposit with the institutions concerned.
The HKMA say that advertisements placed through the internet should be governed by the same principles.
Authorisation of Virtual Banks
A virtual bank is a company which delivers banking services primarily, if not entirely, through the internet or other electronic channels. The term does not refer to existing licensed banks which make use of the internet or other electronic means as an alternative channel to deliver their products or services to customers.
In May 2000, the HKMA issued a Guideline on the Authorisation of Virtual Banks under section 16(10) of the Banking Ordinance. The Guideline sets out the principles that the HKMA will take into account in deciding whether to authorise virtual banks. The main principle is that the HKMA will not object to the establishment of virtual banks in Hong Kong provided that they can satisfy the same prudential criteria that apply to conventional banks. In summary, virtual bank applicants must satisfy the following requirements:
- maintenance of a physical presence in Hong Kong;
- maintenance of a level of security appropriate to their proposed business;
- establishment of appropriate policies and procedures to deal with the risks associated with virtual banking;
- development of a business plan which strikes an appropriate balance between the desire to build market share and the need to earn a reasonable return on assets and equity;
- clearly setting out in the terms and conditions for their services the rights and obligations of customers; and
- compliance with the HKMA's guidelines on outsourcing of computer operation.
In line with existing authorisation policies for conventional banks, a locally incorporated virtual bank cannot be newly established other than through the conversion of an existing locally incorporated authorised institution. Furthermore, local virtual banks should be at least 50% owned by a well-established bank or other supervised financial institutions. For applicants incorporated overseas, they must come from countries with an established regulatory framework for electronic banking. In addition, they must have total assets of more than US$16 billion and will be subject to the "three-building" condition in respect of its physical offices, but not in respect of its cyber network.