Hong Kong 2006 - Financial and Monetary Affairs

Hong Kong maintains a three-tier system of deposit-taking institutions — licensed banks, restricted licence banks and deposit-taking companies. They are collectively known as AIs under the Banking Ordinance. The HKMA is the licensing authority for all three types of AIs.

Only licensed banks may conduct full banking services, including in particular the provision of current and savings accounts and acceptance of deposits of any size and maturity. Restricted licence banks may take deposits of any maturity of $500,000 or above. Deposit-taking companies may take deposits of $100,000 or above with an original maturity of at least three months. Many deposit-taking companies are owned by, or otherwise associated with, licensed banks.

Hong Kong has one of the highest concentrations of banking institutions in the world. In December 2006, there were 138 licensed banks, 31 restricted licence banks and 33 deposit-taking companies, which included the operations of banks from 30 countries around the world. These 202 AIs maintained an extensive network of 1 307 local branches. In addition, there were 84 representative offices of overseas banks in Hong Kong.

The total deposit liabilities of all AIs to customers and the total loans and advances extended by these institutions at the end of 2006 were $4,766 billion and $2,468 billion respectively. The total assets of all AIs amounted to $8,307 billion.

Hong Kong has a robust interbank payment system, which operates through the Real Time Gross Settlement (RTGS) system. The Hong Kong dollar RTGS system, which was launched in 1996, has a single-tier settlement structure, with all banks maintaining settlement accounts with the HKMA. All RTGS payment transactions are settled in real time across the books of the HKMA. Intraday liquidity can be obtained by the banks through the use of their Exchange Fund Bills and Notes (EFBNs) for intraday repurchase agreements with the HKMA.

The US dollar RTGS system and euro RTGS system have also been operating since 2000 and 2003 respectively, allowing real-time settlement of transactions in these currencies, thereby reducing or eliminating settlement risk caused by any time gap. Thanks to the interface between the three RTGS systems, Hong Kong dollar/US dollar/euro foreign exchange transactions can be settled on a payment-versus-payment (PvP) basis.

The Central MoneyMarkets Unit (CMU) Service, established in 1990, is operated by the HKMA to provide a clearing and custodian system for EFBNs and other private debt securities. The CMU system accepts both Hong Kong dollar and foreign currency denominated debt instruments. It has been fully integrated with interbank payment systems, and is linked up with international central securities depositories like Euroclear and Clearstream to enable overseas investors to trade CMU securities. It also has established links with the regional central securities depositories in Mainland China, Australia, New Zealand and the Republic of Korea.

Through its integration with the three RTGS systems in Hong Kong, the CMU enables members to settle Hong Kong dollar, US dollar and euro securities on a delivery-versus-payment (DvP) basis, thereby enhancing settlement efficiency and eliminating settlement risk. The interface also enables automatic intraday repurchase agreements to provide intraday liquidity to participants in the RTGS systems.

The Clearing and Settlement Systems Ordinance, which became effective in November 2004, empowers the Monetary Authority to designate and oversee clearing and settlement systems that are material to the monetary or financial stability of Hong Kong or to the functioning of Hong Kong as an international financial centre. Five clearing and settlement systems, including the CMU and Hong Kong dollar Clearing House Automated Transfer System (CHATS), Continuous Linked Settlement System, US dollar CHATS and euro CHATS, have been designated. Each system was issued a certificate of finality, which provides statutory backing to the finality of settlement for transactions made through the system. The HKMA found all designated systems to be continuously in compliance with the ordinance.

The HKMA was established in April 1993 under the Exchange Fund (Amendment) Ordinance 1992.

Its policy objectives are to maintain currency stability within the framework of the Linked Exchange Rate system through sound management of the Exchange Fund, monetary policy operations and other means deemed necessary; promote safety and stability of the banking system through the regulation of banking business, the business of taking deposits and the supervision of AIs; and promote efficiency, integrity and development of the financial system, particularly payment and settlement arrangements.

The HKMA is an integral part of the Government, but can employ staff on terms that differ from those of the civil service to attract personnel of the appropriate experience and expertise. Its staff and operating costs are charged directly to the Exchange Fund instead of the general revenue. The HKMA is accountable to the Financial Secretary, who is advised by the Exchange Fund Advisory Committee (EFAC) on matters relating to the control of the Exchange Fund.

The authority seeks advice on policy matters routinely from the Banking Advisory Committee and the Deposit-taking Companies Advisory Committee. Both committees are established under the Banking Ordinance. They are chaired by the Financial Secretary and comprise members from the banking industry and other relevant professions.

The Banking Ordinance provides the legal framework for banking supervision in Hong Kong. Under the ordinance, the HKMA is the licensing authority responsible for granting and revoking the authorisation of all AIs, as well as the approval and revocation of money broker licences. The HKMA seeks to maintain a regulatory framework that is fully in line with international standards. The objective is to devise a prudential supervisory system to help preserve the general stability and effective working of the banking system while at the same time providing sufficient flexibility for AIs to make commercial decisions. Hong Kong's framework of banking supervision is in line with the Core Principles for Effective Banking Supervision promulgated by the Basel Committee on Banking Supervision.

The HKMA's supervisory approach is based on a policy of 'continuous supervision' through a combination of on-site examinations, off-site reviews, prudential meetings, cooperation with external auditors and meetings with boards of directors. Since 2000, the HKMA has been using a risk-based supervisory framework for all AIs. This approach puts emphasis on evaluation of the quality of risk management practices and internal controls in respect of various types of risks faced by AIs. On-site examinations are typically focused on areas of higher risk at AIs. In addition, as part of the new capital adequacy framework introduced on January 1, 2007, the HKMA has, based on its risk-based supervisory approach, developed a detailed and rigorous assessment framework to help set the minimum capital adequacy ratios and supervisory priorities of individual locally incorporated AIs and, where applicable, assess the effectiveness of their internal capital assessments.

On the international front, the authority continues to promote cooperation among central banks in the region, principally through the Executives' Meeting of East Asia-Pacific Central Banks (EMEAP)⁴, whose activities cover supervisory liaison and cooperation, development of financial markets and infrastructure, and various areas of central bank operations. The HKMA continues to participate in various regional and international forums for banking supervisors.

In line with its policy of adhering closely to international regulatory standards, the HKMA introduced on January 1, 2007 a capital adequacy framework for all locally incorporated AIs in accordance with the requirements and timetable recommended by the Basel Committee on Banking Supervision (commonly referred to as Basel II). Banking (Capital) Rules and Banking (Disclosure) Rules have been made by the Monetary Authority under the Banking Ordinance to bring the capital adequacy and disclosure requirements in line with the recommendations of the Basel Committee.

The HKMA has taken various initiatives to further strengthen the supervisory framework for the prevention of money laundering and terrorist financing. An Industry Working Group was established in June 2006 to promote industry standards and best practices in the area. The Supplement to the Guidelines on Prevention of Money Laundering was further refined in November 2006 to give effect to latest international standards in relation to wire transfers.

The HKMA continued to work closely with the SFC to ensure that both banks and non-bank financial intermediaries are subject to consistent regulatory measure under the securities regulatory framework. During the year, the HKMA and the SFC for the first time jointly disciplined three current and former relevant individuals of a registered institution. The HKMA also took disciplinary action against a relevant individual and recommended that the SFC take disciplinary action against a former relevant individual in another case. The procedural improvements completed during the year, together with the expansion of the resources, made the investigation and disciplinary review process under the securities regulatory regime more efficient and effective.

The HKMA continued to improve the banking sector infrastructure to further strengthen the stability of the banking system. Assisted by the HKMA, the Hong Kong Deposit Protection Board completed all preparatory tasks and launched the Deposit Protection Scheme on September 25, 2006. Starting from that date, eligible depositors are entitled to compensation of up to $100,000 in the event of a bank failure.

The HKMA continued to strengthen its supervisory framework to promote a safe and sound environment for internet banking development in Hong Kong. In 2006, the banking sector saw continuing growth in the acceptance of internet banking services in Hong Kong. During the year, the number of personal internet banking accounts and business internet banking accounts increased by 15 per cent to around 3.8 million and 44 per cent to about 234 000 respectively. To ensure a safe operating environment for internet banking, Hong Kong is one of the first jurisdictions among developed financial markets to require two-factor authentication for high-risk transactions conducted through internet banking. Since the launch of two-factor authentication in May 2005, 30 AIs have implemented this function and around 1.4 million customers (a 49 per cent increase compared with the end of 2005) have registered for such service. As regards international cooperation, the HKMA hosted the International Conference for Information Technology Supervision in April 2006 as a forum for banking supervisors from 15 major financial markets to share their experiences in the supervision of internet banking and technology risk management.

Since November 2005, the HKMA has been working with the banking industry to ensure a high degree of preparedness for a possible pandemic outbreak in Hong Kong. An industry task force involving eight major banks was established by the HKMA to monitor the latest developments of avian influenza locally and globally and to review the business continuity planning practices. During the year, the HKMA also carried out a round of thematic examinations on the readiness of major AI's business continuity planning for a possible outbreak and issued further guidance to all AIs. In June 2006, the HKMA published an article in the Quarterly Bulletin on pandemic outbreak, including a discussion of the HKMA's possible supervisory response and regulatory forbearance in case of an outbreak. The HKMA continued to work with banking supervisors in other major financial markets to enhance the framework for effective cross-boundary communication in emergency.

One of the functions of the HKMA is to promote and encourage high standards of conduct and sound and prudent business practices among AIs, primarily by way of the Code of Banking Practice. The code is issued by the industry associations and endorsed by the HKMA. It sets out the minimum standards to be followed by AIs in their dealings with personal customers. The code is reviewed from time to time by the Code of Banking Practice Committee, which is convened by the industry associations.