Will virtual banks become the preferred local banks for SMEs?

Companies and trusts have been finding it harder to set up banking services in Hong Kong as successive initiatives to address risks around money laundering and financing of terrorism activities have led to more stringent account opening procedures as banks vet potential customers.

Banks worldwide now have a legal duty to implement ‘Know Your Customer’ (KYC) procedures for all clients, new and old. For corporate accounts, this will include business plans, transaction records and details of all ‘persons of significant control’. Banks face huge fines if found to have failed the relevant compliance checks.

In Hong Kong, banks have been on a de-risking exercise to comply with customer due diligence requirements. This has caused difficulties in opening new accounts and has led to a flood of complaints from businesses experiencing difficulty in obtaining bank services, particularly small and medium enterprises (SMEs). This has implications for Hong Kong’s status as a business and financial hub, but help may be at hand from a new direction.

As part of a series of initiatives to boost the banking sector, the Hong Kong Monetary Authority (HKMA), recently announced it would issue licences to virtual banks this year. These virtual banks would have no physical presence – except in fulfilling regulatory requirements for at least one physical branch in the city to handle complaints – and would offer banking services primarily through the Internet or other digital channels.

The HKMA welcomes the establishment of virtual banks in Hong Kong, which it believes will promote fintech and innovation in Hong Kong and offer a new kind of customer experience. It said earlier this year that virtual banks should seek to include more SMEs. The HKMA also said virtual banks should not impose minimum balance requirements or low-balance fees.

“Overseas experience has shown some successful virtual bank operations, while SMEs could get better banking services and lending,” said Arthur Yuen, deputy chief executive of the HKMA. “We expect virtual banks will focus on retail and SME businesses, but we will not require what type of services they must offer to customers. They could choose their business scope, ranging from payments, deposits and loans, to wealth management and other lending.”

The introduction of virtual banks is expected to shake up the Hong Kong market by allowing new challengers to enter an industry dominated by large, traditional banks. Digital banking has already swept across several other financial centres, ushering in a wave of technology-driven challenger banks with limited banking capabilities.

New banking licences are rarely issued in Hong Kong and the new rules will permit lenders to operate 100% digitally and avoid building out expensive branch networks. They will, however, be required to build adequate capital bases depending on the size of their business.

But unlike many other jurisdictions, Hong Kong’s virtual banking licences will be full retail banking licences, something that is expected to attract some of the powerful Chinese technology companies.

With over 50 companies – including established players such as HSBC, Standard Chartered and Bank of China – having expressed interest in applying for virtual banking licences, this new regulation could be a major game changer for Hong Kong by boosting competitiveness and elevating the customer experience. The deadline for applications is 31 August.

Julia Connolly, Managing Director of Sovereign Trust (Hong Kong) Limited, said: “Sovereign will be following this interesting development closely and we plan to nurture relationships with virtual banks as soon as they are open for business. In the meantime we can offer corporate banking solutions with some premier banks in Hong Kong and several overseas banks.”

With the wider adoption of FinTech, Hong Kong may outshine other global financial centres once again.

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