Virtual Banking Launch Shouldn't Erode Hong Kong Banks' Advantages

The Hong Kong Monetary Authority has awarded three virtual banking licenses to a number of joint ventures with businesses expected to launch in six to nine months. The virtual banks only need to maintain a principal of business in Hong Kong as a contact for the HKMA and will benefit from a lower cost base with no physical branch requirement. The three license winners are Livi VB, consisting of BOC Hong Kong, JD.com, and Jardine Matheson; SC Digital Solutions, a joint venture of Standard Chartered, HKT, PCCW, and Ctrip; and ZhongAn Virtual Finance, a partnership between ZhongAn Online and Sinolink. Another five virtual bank applications are being considered by the HKMA.

While the new entrants should increase competition in the Hong Kong banking sector, we do not expect competitive advantages to be eroded for HSBC, Hang Seng Bank, and the main operation of BOC Hong Kong, all of which we rate as having a narrow economic moat. The Hong Kong banking sector is already highly competitive, and all three banks have seen their large deposit market shares remain largely stable. Given the high population density and maturity of the market in Hong Kong, we continue to see the banks’ existing branch networks as valuable touchpoints for customer service and cross-selling opportunities. All three banks have supplemented their branch networks with full-service digital platforms.

For Hang Seng Bank, rent, premises and equipment, and depreciation make up close to 30% of total operating expenses. The majority of the balance is employee cost. While part of this is attributable to head count in the branch network, the banks have automated and centralized processes. This has allowed front-line staff to focus on sales activities to generate revenue and reinforces the bank’s competitive position in maintaining its low-cost deposit base. If the virtual banks can successfully pry away low-cost deposits from the existing banks, we see this as a key risk for the traditional banks.

In the more advanced and tech-savvy mainland China, virtual banks such as Tencent’s WeBank act as a digital platform, taking commissions by matching prospective borrowers on Weixin with the traditional banks, depending on the risk level. In our view, this is due to the lack of low-cost deposits for virtual banks, which places them at a funding disadvantage. This in turn will cap a virtual bank’s ability to take on balance sheet risk, or issue a large balance of loans, and to manage credit risk. The Livi VB joint venture will commit capital of HKD 2.5 billion, far exceeding the minimum paid-up capital of HKD 300 million required by the HKMA. The HKD 300 million is in line with capital requirements under the Banking Ordinance. However, the committed capital is small relative to Hang Seng Bank’s equity base of HKD 162 billion, for example.

We believe the secondary moat source in switching costs also comes into play. While the banking industry is highly competitive and most people have accounts across multiple banks, customers usually have a higher number of products with their main bank. This is supported by a broad portfolio of financial products. For WeBank in China, products are limited to personal finance and microcredit, targeting individuals and small and micro businesses. The loans are short term with a maturity of three to six months and denominations of CNY 5,000-30,000. Again, most loans are issued by the traditional banks. On balance, we believe the virtual banks will see some success in attracting tech-savvy customers with basic financial needs.