VIRTUAL BANKING - OVERVIEW OF THE CURRENT LANDSCAPE

This shows an open attitude towards virtual banks, in line with HKMA’s goal to bring Hong Kong into a new era of smart banking.

Virtual Banking is nothing new. A virtual bank (sometimes referred as a digital-only bank) leverages IT as a core capability to provide clients mainly retail banking services through electronic channels without having to visit a branch. Such service have launched in US and UK for a number of years, and has been expanding fast given the growing segment of digitally literate customers who want simplicity, transparency and useful services.

Overseas experience has shown some successful virtual bank operations already. Taking US as an example, the First Internet Bank and Bank of Internet USA are the two leading virtual banks at the moment. As of now their assets amounted to US$8.5 billion and US$2.4 billion respectively, with a diversify product offerings ranging from saving accounts, credit cards to personal loans and mortgages. Virtual banking is a bit slow to take off in UK with the first digital-only bank launched in 2017 to provide savings accounts and small business loans.

Although these digital-only banks are ‘virtual’ in nature, they are considered as banks for all intents and purposes and abide by the same rules as traditional retail banks. In UK, these virtual banks are required to fulfill the requirements for a small specialist bank before engaging in the virtual banking business:

• Authorization obtained from the Financial Conduct Authority (FCA)
• Banking license issued by Bank of England’s Prudential Regulation Authority (PRA)
• Capital requirements : €5 million plus a capital planning buffer to €1 million or £1 million (whichever is higher)  

In US, the applicant intended to start a virtual banking business must follow the same process for starting a traditional banking business as below:

• First to receive approval for a federal or state charter
• Next to obtain approval for deposit insurance from the Federal Deposit Insurance Corporation (FDIC)
• The applicant must also comply with the capital adequacy guidelines of their primary federal regulator

Hong Kong is the 1st jurisdiction having a specific guideline detailing the rules and expectation for the operational and risk management of a virtual bank, setting out clear criteria for priority handling of virtual bank applications. This shows HKMA determination to promote the adoption of financial technology and innovation in Hong Kong. Since the announcement of the guideline, more than 50 companies from across the world have expressed interest in applying for virtual bank licenses. Yet, we foresee that the actual number of applicants will be less, due to the below challenges in obtaining the license:

• High capital requirements– virtual banks looking to set up in Hong Kong will need to have at least HK$300 million (US$38.36 million) in capital, which is the same standard applied for all licensed banks and stipulated in the Banking Ordinance. Such can be one heavy burden for the start-ups eager to enter into the virtual banking business.
• Identification of a sound business model – HKMA consider virtual banking as a new business model. Especially for the Fintech startups & non-banks, they need to identify and establish a sustainable business model in order to meet HKMA requirement on the viability of business plans. 
• Fulfillment of the regulatory standards– virtual banks face the same regulatory challenges as physical banks. However, since they never actually see their customers and the operating model is much different than the traditional banks, the regulations can be more difficult to meet.

Nevertheless, it is obvious that HKMA is keen to encourage virtual banks as art of the smart banking transition.  With more customers shifting to digital channels and the relaxation of regulations, it is foreseeable that more new players, mostly start-ups and Fintech firms, will gear up to engage in the Hong Kong virtual banking business.