Internet Transaction Costs Tiny Relative To Branches
Recent estimates suggest that the cost of a telephone banking transaction for the provider is half that of the same branch-based transaction, ATM transaction costs are as little as 20% of branch-based costs and internet banking transactions can be processed for just 2% of the cost of branch transaction. The players who have the resources to develop these systems will ultimately enjoy much lower cost/income ratios than they do today. But the development cost of such systems is enormous and smaller banks are unlikely to be able to go it alone.
E-Banking a Necessity
e-banking service has become a necessity for the success of a bank, not only because of cost savings, but also for recruiting the desirable customers. Overseas market studies found that those banks with a strong brand image and the first to launch Internet banking will be able to recruit the young affluent customers (also long term potential customers). These customers can bring in profitability, as they usually have greater demand for financial services and carry lower credit risks. Those banks failing to cope with the technology revolution will result in retaining only the less profitable customers.
Smaller banks, such as Liu Chong Hing Bank (LCHB), International Bank of Asia (IBA) and FPB Bank, may have to invest more on the IT and upgrade their operating platform and procedures before considering e-banking on a large scale. They are also the potential to become merger and acquisition targets as discussed below. Automated banking service has been well received in Hong Kong. Hang Seng Bank (the second largest local bank) has over two millions of customers from all walks of life in Hong Kong, yet 82% of the transactions are performed through automated channels. Off-counter transactions will increase further when their customers become more familiar with the Internet banking and mobile banking services.
Future Competitive Landscape
Today?s Playing Field
The local banking scene in Hong Kong today essentially has four key segments:
? Large universal financial services providers such as HSBC, Standard Chartered and the Bank of China Group
? medium-sized local banks with broad franchises such as HSB, BEA and DHBG
? Smaller banks focussed on small and medium-sized companies and sometimes specific ethnic segments such as Hindu Banks and Muslim orientated organisations
? Foreign and Niche players specialising in key market segments (Citigroup for high net worth individuals or ABN AMRO in the mortgage arena).
Larger Players to Remain Unchanged
The large players are likely to remain in their current form. The medium-sized players have relatively little to gain from an acquisition of a smaller bank (some cost synergies) unless the target bank enjoys a specific franchise segment in which the acquirer has little presence. However, these medium-sized players could be attractive to foreign banks looking to expand their international franchise (ABN AMRO, OCBC).
Corporate-Owned Banks Obvious Targets
Corporate-owned smaller players (listed or unlisted) could find themselves available for sale as their conglomerate or foreign parents seek to focus on core businesses. In particular banks with significant Japanese shareholders would be obvious acquisition candidates for larger or overseas banks who can bring additional expertise, specifically in the area of technology. The level of family ownership amongst small banks in Hong Kong remains high and it likely to continue to be difficult to gain control of such banks except in the case of family financial distress ? instead we could see greater focus on niche strengths.
Mainland Majorities Likely to Remain
Finally, there are the so-called ?red chip? banks where the major shareholder is a mainland entity. Even if the operating environment deteriorates and profitability is eroded for these banks they could find themselves ultimately wholly-owned by mainland parties with profitability a secondary concern to prestige value.
The Players (Mergers or Acquisition targets)
Potential Acquirers
The very largest operators in Hong Kong?s banking sector are unlikely to be interested in further expanding the franchise through acquisition. However, mid-sized players such as BEA and DHBG could have an interest in acquisitions that would add new products, services or customer segments (it is known, for example that DHBG did cast an eye over Kwong On Bank). Amongst smaller players, IBA probably has most financial clout through its parent whilst DSF may well entertain the prospect of a merger of equals. A number of foreign players are also believed to be interested in entering or expanding their presence in Hong Kong, most notably ABN AMRO and GE Capital and OCBC (DBS having already acquired Kwong On Bank).
Potential Targets
Potential targets in our coverage universe are DSF and WHB (relatively high asset quality and some income diversification coupled with major shareholders with less than 50% interests). DHBG with its successful credit card and direct mortgage business would be an excellent entry for a foreign player were majority shareholder Guoco to decide to sell. FPB was recently taken off the market by its parent but WLB could be regarded in play if DBS decides to unload its stake now that it has another vehicle. HKCB, after recent well-publicised problems, might even be actively seeking a suitor. LCHB, whilst controlled by a combination of the Liu family and Cosco Pacific, appears attractive at least in valuation terms (although the franchise it would bring is unclear).
Smaller banks, such as Liu Chong Hing Bank (LCHB), International Bank of Asia (IBA) and FPB Bank are also key targets of mergers and acquisitions.
Conclusions and Recommendations
In order to survive in Hong Kong?s banking sector some recommended strategies that could be adopted but are not limited to include the following:
? Consolidate through merger or acquisition.
? Because of the standardized features of most of the banking products, keen price competition is driving down the average loan yield and therefore profits. Net profit growth will mainly stem from the banks? aggressive promotion of the fee and commission income services and lower provision charges as credit quality continues to improve.
? Past investment in technology is paying off. While it will be unlikely to achieve a spin-off of the e-banking operations to boost valuation in the near term, banks with comprehensive e-banking service will be on higher grounds to compete for young and higher-value customers. However, clear strategic direction as to future technology adoption will be needed if any bank is going to be able to compete effectively in the future.
? The growing popularity of e-banking will further strengthen large banks? market position. Equipped with more advanced information technology and leveraging on a broad customer base and strong consumer confidence, large banks are set to gain market share from their smaller peers. Again, the industry?s consolidation will increase.
? Customers demand breadth and depth of banking services; Educated young people, middle-income earners and the high net-worth individuals are the more profitable market segments to the banks. While the high net-worth individuals are unlikely to be loyal customers for the local banks, the growing affluence of the educated young people and middle-income customers will provide greater growth opportunities for the banks. These customers are more concerned about their life quality and have better financial planning for protecting themselves and their families. They will demand a broader range and more customized financial services as well as the convenient account services. In addition, the increasing price transparency will drive down the profit margin of the transaction-oriented banking services. Demand for wealth management and bank assurance will accelerate and become a major revenue source to the banks in the coming few years.
? Market segmentation and marketing strategy; Local banks are offering similar financial services. The management quality and marketing strategy make the difference. Cost-effectiveness and the ability to address customer needs have become more critical. To leverage on the existing customer base, banks have placed more emphasis on data mining to segment customers into micro-niches and apply more effective marketing strategies to cross-sell services. Through various distribution channels including branches, call centers and direct mailing, banks have to actively promote their services. Banks in Hong Kong need aggressive and pro-active management together with global and Chinese market exposure.
? Customer confidence is the essential; Trust and awareness are the two key elements for the success of a bank. Besides an effective marketing strategy and a good product mix, banks must have a strong capital and reasonably large operating scale to cultivate customers? confidence. Local banks have survived the Asian currency crisis and they are in good shape, thus demonstrating their financial strength and management ability to handle tough situations. However, mid-cap banks still have to compete at price levels for both customer loans and deposits. Brand building.
? Achieve some of the benefits of merger without actually merging. Notable is the recent example of the Bank Consortium Trust, which has been formed to develop the infrastructure for common Mandatory Provident Fund and its products, which will be marketed through the branch networks of the participating banks. Ten banks are now involved one way or another in this project, which will enable development and IT costs to be shared and the economies of scale which are normally available only to larger institutions to be achieved. This is an imaginative response to the competitive environment and one, which the HKMA strongly supports. It is expected that this co-operation can be extended into other business areas, and hopefully, as the banks work increasingly closer and closer together, relationships can be forged which will lead in the direction of eventual shared ownership. This will help when competing on a global basis not just in Hong Kong.
? Look to other alternatives of mergers such as alliances in potential regional powerhouses such as China, where, WTO entry is likely to increase competition on the mainland and offer local Hong Kong banks in particular, greater opportunities.
Conclusions of the oligopolistic environment of the banking sector in Hong Kong will lead to:
? Interdependence in decision making, no one bank will make a move without the other banks following suit.
? Oligopolies (therefore the Hong Kong banking sector) avoids price competition
? In the long run consumers will pay high prices and consume less than in a pure competitive market
? Consumers may pay economic profits in the long-run
? Employees of possible mergers and acquisitions may require training and assistance.
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