As Hong Kong joins others in exploring the use of a digital currency, there are more issues to consider than just technological and regulatory ones. Photo: Shutterstock
by Neal Kimberley
by Neal Kimberley

Could a digital Hong Kong dollar undermine the local banking sector? HKMA must take note

  • The HKMA’s feasibility study must think through the impact of options for e-HKD issuance: will commercial banks take on the role, as they do now for physical banknotes, or will the Monetary Authority issue the digital currency itself?
The Hong Kong Monetary Authority has set up a working group “to study the technology and regulatory issues related to an e-Hong Kong dollar”, said Eddie Yue Wai-man, the authority’s chief executive, on June 8. This is a timely move but there are more issues to consider than just technological and regulatory ones.

The HKMA, the city’s de facto central bank, “will have a conclusion in about 12 months”, Yue added. The central bank digital currency (CBDC) feasibility study was announced at the launch of fintech 2025, the HKMA’s wider fintech plan for Hong Kong for the next few years.

The challenge will be to craft an e-Hong Kong dollar (e-HKD) that will have popular appeal, tick the regulatory boxes but, crucially, won’t disrupt the business models of Hong Kong’s commercial banking sector.

Yue noted that “Hong Kong people, nowadays, are more willing to use digital banking services”, while HKMA deputy CEO Howard Lee stressed that “the e-Hong Kong dollar will just be an electronic version of a physical banknote”. This means the “mechanism of the issuance of e-Hong Kong dollars will be the same as the issuance of physical banknotes under the [Hong Kong currency’s US dollar] peg”, Lee said.

China’s official app for the digital yuan is seen on a mobile phone next to 100-yuan banknotes. Talks are ongoing between the HKMA and PBOC about the use of the digital yuan for cross-border payments. Photo: Reuters
In short, an e-HKD for use by Hongkongers in the domestic market might have popular appeal, given the receptiveness of Hong Kong people to digital banking services. It would presumably coexist with, but be distinct from, the e-yuan, the use of which in Hong Kong for cross-border payments remains a matter of discussion between the HKMA and the People’s Bank of China.

On the regulatory side, the HKMA is arguably well placed to make central bank digital currency design choices that reinforce an existing Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) regime that the International Monetary Fund only last week characterised as “solid”.

What remains unclear, when it comes to e-HKD issuance, is whether the HKMA will co-opt the existing system, where three commercial banks – HSBC, Standard Chartered and Bank of China (Hong Kong) – are authorised banknote issuers, or whether the Monetary Authority might issue the e-Hong Kong dollar itself.

Commuters walk underneath HSBC’s headquarters in the Central district of Hong Kong. The bank is one of three authorised banknote issuers in the city. Photo: Bloomberg

Either route has its pros and cons. A Bank for International Settlements (BIS) working paper, published earlier this month, argued that “a CBDC should let central banks provide a universal means of payment for the digital era, while at the same time safeguarding consumer privacy and preserving the private sector’s primary role in retail payments and financial intermediation”.

Establishing e-HKD issuance along the same lines as Hong Kong’s existing system for banknotes would arguably meet many of the criteria referenced by the BIS working paper but significant questions would still need to be addressed about the level of information the three commercial banks would be expected to feed back to the HKMA, if only to reinforce the continuing solidity of the Monetary Authority’s own AML/CFT regime. 

The HKMA might conclude that, for regulatory reasons, the existing system should not be used as the basis for e-HKD issuance, and so could instead choose to issue the e-HKD itself.

But that option is no panacea. Such a central bank digital currency might be a magnet for depositors, especially for funds currently held with commercial banks in Hong Kong that are in excess of the HKMA’s Deposit Protection Scheme.

China digital currency: when will the e-yuan be launched, and what will it be used for?

In its New Forms of Digital Money discussion paper, published on June 7, the Bank of England argued that certain depositors could perceive new forms of digital money as safe enough to attract their uninsured commercial bank balances, a point that the BIS working paper also referenced.

“Household investments into a CBDC could substantially increase the balance sheet of central banks, and crowd out deposits at commercial banks,” the working paper argued. That could put pressure on the business models of commercial banks; since they finance loans with deposits, the paper noted, a central bank digital currency could negatively impact an economy.

This argument would surely be applicable to any e-HKD issued directly by the HKMA and be a key issue for it to consider.

Commercial banks, not central banks, make direct loans to firms and households, and it would clearly never be in Hong Kong’s interests to see an e-HKD potentially undermining a local banking sector that the IMF presently characterises as “well capitalised, profitable, and [where] non-performing loan ratios remain low”.

Hong Kong may well prove to be fertile territory for a central bank digital currency but the HKMA has much to ponder as it crafts its e-Hong Kong dollar strategy.

Neal Kimberley is a commentator on macroeconomics and financial markets