Banks face hard crisis lesson
The banking sector in Hong Kong has demonstrated a high level of resilience in weathering the negative effects of the Asian crisis compared with banks in other parts of the region.
This resilience, however, is no magic pill for long-term survival and prosperity.
This year has been characterised by a substantial return of global economic growth to the crisis-hit countries in the region.
Recovery needs to be propelled by capital inflow. Can Hong Kong banks help and benefit from this round of foreign capital inflow into the region? The matter needs to be examined in the context that there has been a change in the landscape of the region's financial services industry following the Asian crisis.
Incompetent domestic players have either been kicked out or have had to undergo thorough but relatively rapid structural reform to reinvent themselves and become modern participants.
Foreign institutions that burnt their fingers from reckless lending before the crisis have been replaced by international banking groups that are more risk averse, competent and cost efficient and which have expertise operating in a multi-national environment.
This kind of evolution and reform process, however, has not happened in Hong Kong on the same scale and to the same depth as it has in other crisis-hit countries.
Hong Kong banks are now facing competition from strengthened regional players as well as from the always strong international players.
That is why the Hong Kong Monetary Authority over the past 12 months has urged more market-driven mergers and acquisitions in the sector in an effort to strengthen its regional competitiveness.
However, consolidation without fundamental changes in the lending culture and practices of the banks will not ensure stronger participants.
Market observers are inclined to believe that two weak banks merging will not necessarily produce a stronger institution.
Wing Hang Bank chairman Patrick Fung Yuk-bun has also pointed out that most family-owned banks in Hong Kong are under no solvency pressure to merge with one another.
Instead, most saw their capital-adequacy and liquidity ratios improve in the first half, due to the lack of promising lending opportunities.
Hong Kong banks remain - as Goldman Sachs Asia executive director Roy Ramos once described them - no more than glorified pawnshops, relying heavily on collateral with very underdeveloped cash-flow lending capabilities.
Reliance on collateral and their highly conservative stance in lending might, to an extent, explain why they remained relatively unscathed by the crisis.
Not until recently have Hong Kong bankers and regulators started talking about how to develop cash-flow lending capabilities on top of their traditional collateralised lending.
Still, the discussion remains limited in scope.
Guoco Group executive director James Eng, who heads the group's commercial banking arm, Dao Heng Bank group, said even the world's top lenders, however well equipped with cash-flow lending expertise, still looked for collateral.
This practice has to be changed. The problem is that few know in what direction the changes should move.
Traditional banks are starting to feel the heat from the urgency to reform their lending practices due to the so-called disintermediation process in the international finance market.
The process essentially describes the rapid development of the international capital market that takes over the traditional banks' role in taking deposits from savers and diverting the funds to businesses.
Hong Kong banks want to lend to credit-worthy blue-chip companies. But these companies are capable of borrowing more cheaply from the international capital market.
Since the beginning of the year, many blue-chip companies have established their own multi-currency medium-term note (MTN) issuance programmes, under which many note issues have been launched.
To those blue-chip companies, these MTN programmes not only provide an alternative source of funding but also help them to lock in their funding costs, because many programmes allow issuance of fixed-rate notes.
With the disastrous Thursday of October 23, 1997 - when the overnight interbank rate climbed to a record high of 280 per cent - still in mind, these MTN programmes undoubtedly are attractive to blue-chip companies.
While the process of disintermediation continues, small and medium enterprises (SMEs) with no access to the international capital market still need support from financiers.
Excluding the blue-chip borrowers, the landscape of the corporate banking market in Hong Kong will get back to what it looked like in the 60s and 70s, when most of the companies were SMEs.
In this environment, the success of a corporate banker will be dictated by how thorough he can understand the businesses of his SME customers and how well he can make use of his understanding to create high quality assets.
To this end, a very encouraging development is underway at Standard Chartered Bank.
Group executive director Mervyn Davies said the bank was in the process of setting up a team specifically dedicated to looking at business opportunities with startup, hi-tech and Internet companies - which often fall into the SME bracket.
The bank was not only looking for opportunities to generate fee income from providing consultancy services to these startups, but also was looking for lending opportunities, he said.
This is definitely a good sign if other industry participants follow.
However, some banks, such as First Pacific Bank and Dao Heng Bank, have clearly defined their roles as normal commercial banks and have refrained from taking the excessive risks of lending to startups.
One cannot challenge the position taken by these two banks because, after all, lending to a particular sector or a particular company should remain a commercial decision driven by market forces.
The question is whether or not we have proper market infrastructure in place to attract venture capital funds to fill the gap of lending to startups.
Development of the second board of the Hong Kong stock exchange, more commonly known as the Growth Enterprise Market (GEM), is appropriate under this context.
The GEM, when properly developed with appropriate depth and liquidity, could provide an outlet for venture-capital funds to cash in their equity investments in startups, according to stock exchange executive director K. S. Lo, who heads the new market.
The GEM is good for the local banking industry as well, because it pushes small companies listed there to maintain a very high level of financial information disclosure and transparency, boosting the confidence of banks in supporting the SME sector.