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The Future Of Banking: Hong Kong's First Virtual Bank Licenses Will Rejuvenate The Banking Sector

HONG KONG (S&P Global Ratings) March 29, 2019--The issuance of the first 
virtual banking licenses in Hong Kong is likely to inject new energy into the 
city's banking system. S&P Global Ratings expects the virtual banks to carve 
out a niche market in the Greater Bay Area of Hong Kong, Macau, and Guangdong 
that could spur growth in the banking industry. In our opinion, the increased 
competition in the retail segment will eventually benefit customers and small 
and micro enterprises, and promote financial inclusion.

"Virtual banks could become a new growth engine as they compete fiercely with 
traditional banks on customer experience, product innovation, and delivery 
channels," said S&P Global Ratings credit analyst Fern Wang. "The virtual 
banks' low-cost business model should allow them to reach customer segments 
that were previously underserved."

The Hong Kong Monetary Authority (HKMA), the de facto central bank, granted 
the first batch of three virtual banking licenses on March 27, 2019. The three 
entities expect to launch their services within the next six to nine months.

Significant cost advantages on overheads and infrastructure costs should allow 
the virtual banks to offer a broader range of digital products to underserved 
customers at a lower cost. This could make providing smaller ticket size 
loans, for example, become more viable and fill a gap in inclusive finance.

The virtual banks will not impose on customers any minimum-balance 
requirements or charges on low balances. The lack of physical presence could 
also mean that these banks would likely need to offer higher interest rates to 
compete for deposits, potentially intensifying the pricing competition for 
deposits. We believe the virtual banks' lower overhead costs could also make 
up for their higher funding costs in the long run, especially in Hong Kong 
where rental costs are high.

At first, the virtual banks are likely to have limited product offerings and 
focus on retail banking, but we believe they will gradually expand their 
scope. For example, their cross-selling abilities should increase as they 
obtain relevant licenses from the Securities and Futures Commission and 
Insurance Authority to offer brokerage, insurance, asset management, and other 
financial management products. We also expect virtual banks to sell rather 
simple mainstream products, given the lack of face-to-face interaction with 
potential customers.

Cross-border financial innovation and cross-border selling of products are 
among the key objectives in the Greater Bay Area initiatives. The area has a 
combined GDP of US$1.5 trillion with a total population of around 70 million 
as of end-2017. As such, we see significant growth opportunities for the 
cross-border selling of various financial products once the three governments 
finalize the "Wealth Management Products Connect" and "Insurance Connect" 
initiatives. It would therefore be a natural progression for virtual banks to 
be allowed to acquire customers remotely across the border in the long run, in 
our view.

We do not believe the introduction of virtual banks in Hong Kong will change 
HKMA's banking supervision philosophy. The authority will apply the same 
supervisory requirements on all banks. The HKMA has also made it clear that it 
will not tolerate predatory behavior. Offenders will be dealt with seriously, 
including having their licenses suspended or revoked. 

Hong Kong's banking sector is largely dominated by four note-issuing banks: The
Hongkong and Shanghai Banking Corp. Ltd.; Bank of China (Hong Kong) Ltd. 
(BOCHK); Standard Chartered Bank (Hong Kong) Ltd. (SCBHK); and Hang Seng Bank 
Limited, a subsidiary of the Hongkong and Shanghai Banking Corp. These banks 
represent around 60% of the banking sector's market share by total assets.

"In our view, Hong Kong's top banks are likely to maintain their market 
leadership due to their well-established franchise," said Ms. Wang. 

Virtual banks are more likely to be niche players than direct challengers to 
the existing big four banks. And, BOC Hong Kong (Holdings) Ltd., the holding 
company of BOCHK, and SCBHK are even the major shareholders of two of the 
licensed virtual banks.

This report does not constitute a rating action.
S&P Global Ratings, part of S&P Global Inc. (NYSE: SPGI), is the world's 
leading provider of independent credit risk research. We publish more than a 
million credit ratings on debt issued by sovereign, municipal, corporate and 
financial sector entities. With over 1,400 credit analysts in 26 countries, 
and more than 150 years' experience of assessing credit risk, we offer a 
unique combination of global coverage and local insight. Our research and 
opinions about relative credit risk provide market participants with 
information that helps to support the growth of transparent, liquid debt 
markets worldwide.
Primary Credit Analyst:Fern Wang, CFA, Hong Kong (852) 2533-3536;
Secondary Contact:Ryan Tsang, CFA, Hong Kong (852) 2533-3532;

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