Global Financial and Banking Systems PDF Study Guide 2024

**Chapter 1** Global financial and banking systems **Learning outcomes:** Upon completion of this chapter, learners should be able to: - understand the relationship between economic sectors and the financial system - synthesize the role of money and financial intermediaries in the f...

**Chapter 1** Global financial and banking systems **Learning outcomes:** Upon completion of this chapter, learners should be able to: - understand the relationship between economic sectors and the financial system - synthesize the role of money and financial intermediaries in the financial system - identify the major trends and developments in the global banking and financial services arena and the underlying forces - synthesize the changing landscape of banking and financial services in Hong Kong and China. **\ ** **List of topics** +-----------------------------------------------------------------------+ | 5. **The Role of the Financial System in the Global Economy** | | | | 8. **Supply and Demand** | | | | 9. **Economic Sectors** | | | | 10. **Flow of Funds** | | | | 11. International Capital and Investment Flows | | | | 12. Participants in the Global Financial System | +=======================================================================+ | 1. **Money and Banking System** | | | | 1. Supply of Money | | | | 2. Functions of Banking in the Financial System | | | | 3. The Global Banking Business | | | | 4. Central Banks | | | | 5. The Bank Organization | | | | 6. Banking and Financial Services in Hong Kong | | | | 7. Banking and Financial Services Industry in China | +-----------------------------------------------------------------------+ | 2. **Chapter summary** | | | | 3. **Reference summary** | | | | 4. **Review questions** | +-----------------------------------------------------------------------+ **\ Introduction** The formation of financial system is closely related to the global economic environment. Understanding the basic supply and demand theory is essential to know in what aspects different economic sectors influence the flow of capital and their roles in global economy, by which building up the foundation of global financial system and the importance of liquidity. The functions of financial institutions existing in the global flow of funds are discussed, leading to the concepts of money and banking system, which is closely related to the stability of global economic system. Banking systems of Hong Kong and China are highlighted since the recent development of both Hong Kong and China financial markets are highly correlated. 1. **The Role of the Financial System in the Global Economy** 1. **Supply and Demand** Society needs to make choices about what should be produced, how those goods and services should be produced and who is allowed to consume those goods and services. In conventional economics the market answers these questions by way of supply and demand. Under conditions of competition the market (everyone, producers and consumers together) determines the price of a product, and the price determines what is produced and who can afford to consume it. Price provides the incentive to both consumer and producer. High prices encourage more production by producers, but less consumption by consumers. Both incentives push the price to balance the forces of consumption (demand) and production (supply). Economists call this balance "equilibrium". This natural mechanism requires no external institution for direction (or only a minimum amount) nor any altruistic motivation by either consumers or producers. Besides being the natural consequences of economic forces, the supply and demand mechanism (the economic model) provides the most efficient economic outcomes possible. Satisfaction for society is maximized at minimum cost. The market mechanism's efficiency is always located on the production possibility curves frontier, where all resources are fully utilized (points within the production possibility curves are inefficient by definition, since resources are not utilized). This core model of supply and demand explains why economists usually favour market results and seldom wish to interfere with price. Setting minimum wages, for instance, and intervening in trade violate the spirit of the model and lead to inefficient outcomes. Demand indicates an individual's willingness to buy quantities demanded at different price levels with other factors unchanged. A lot of factors affect demand for a product: - Level of income - Taste and trend - Consumer's expectation of future price - Size of population - Price of related goods e.g., substitutes and complements Exhibit 1.1: Change in Quantity Demanded and Demand +-----------------------------------+-----------------------------------+ | Change in quantity demanded | Change in demand | +===================================+===================================+ | Price | Price | | | | | 0 Q~d0~ Q~d1~ Q~d~ | 0 Q~d~ | +-----------------------------------+-----------------------------------+ | move along the same demand curve | shift of the entire demand curve | | (due to change in price of goods) | | +-----------------------------------+-----------------------------------+ Taking the above exhibit 1.1, let's consider the market for borrowing money on credit card. According to the law of demand, a lower price (i.e., lower interest rate; P1 \< P0) increases the quantity demanded (i.e., the amount of borrowed money; Q~d1~ \> Q~d0~). As interest rate decreases, consumers increase the quantity they borrow. Supply indicates the supplier's willingness and capability to supply the quantity of goods at different price levels with other factors being unchanged. A lot of factors will affect the supply of a product: - State of technology - Number of suppliers - Suppliers' expectation of future price - Price of related goods, e.g., substitutes and complements Exhibit 1.2: Change in Quantity Supplied vs. Change in Supply Taking the above exhibit 1.2, let's consider again the market for borrowing money on credit card. According to the law of supply, a higher price (i.e., higher interest rate; P1 \> P0) increases the quantity supplied (i.e., the amount of money to be borrowed; Q~s1~ \> Q~s0~). As the interest rate on credit cards increases, the quantity of money to be supplied in the credit card market increases. The market combines buyers and suppliers in an exchange. In economics terms it combines demand and supply curves to determine an equilibrium price, which is the price at which the quantity demanded is equal to the quantity supplied (i.e., equilibrium quantity), reaching an almost perfect allocation of demand and supply. At this point, prices are perfectly set to interest consumers and suppliers produce just enough amount of product, selling at the desired price of interest consumers. Exhibit 1.3: Equilibrium Price Taking the above exhibit 1.3, let's continue to consider the market for borrowing money on a credit card. The interest rate in this situation could be considered as the cost of money. Supply curve and demand curve cross at the equilibrium point. Equilibrium occurs at an interest rate of 150 basis points (i.e., the interest rate on credit card being 1.5%), where the quantity of funds demanded and the quantity supplied are equal at an equilibrium quantity of \$40 billion. 2. **Economic Sectors** There are respective sectors in the economy demanding and supplying different products and services, including: 1. **Household sector** This is represented by consumers of goods and services. It also refers to the retail sector. Households spend and invest, so this sector is considered as a lender of funds, and households' demand for different products and services is one of the driving forces of demand. 2. **Business sector** This is represented by producers of goods and services, one of the driving forces of supply. On the other hand, members within this sector need funds for production, and hence are regarded as borrowers of funds. At the same time, they consume goods and services and make investments too, so they are considered as a lender/provider of funds as well, and considered to be another driving force of demand, demanding funds for business operations, products and services. 3. **Government sector** The Government needs to spend money in achieving economic, political and social goals. It is primarily a borrower of funds. At the same time the government buys goods and services, so it is also a lender of funds. Thus, the government could be classified as both the demander and supplier of funds in the market. 4. **Overseas sector** Most countries rely on import and export trading with other parties. Hong Kong also relies heavily on external trade and investment, so overseas countries are considered as lenders, demander of products and services, of funds to Hong Kong. 3. **Flow of Funds** Flow of funds can be classified as direct and indirect financing: Exhibit 1.4: Fund Flows 5. **Direct financing** Upon reaching an agreement on the amount, interest rate and risk profile, the borrower obtains funds directly from the lender. 6. **Indirect financing** When borrower and lender cannot agree on each other's terms, the financial intermediary is there to facilitate fund flow. The intermediary borrows the funds from the lender and re-lends the amount to the ultimate borrower. The intermediary assumes the risk involved in return for a brokerage fee and higher rates from the borrower. 7. **Importance of financial institutions in the flow of funds** In the case of direct financing, it is not easy for borrower to obtain enough funds from lenders, as the wills of households are not collectively managed. Borrowers would have to put in a great deal of effort to get enough funds from different lenders. This difficulty will reduce the will of operating businesses, as a result, less business units could be expected. With less business unit, the chance for the households to earn money would be reduced as well, in return, the funds available among households would be reduced, making operating business, borrowing and lending activities even less than before. With financial institutions, the boundaries between lenders and borrowers would be reduced, making economic activities more active and strengthen economic activities. 4. **International Capital and Investment Flows** Financial market globalization has facilitated cross-border flow of capital in the last twenty years. Countries providing the capital can earn a return, while those countries receiving the capital can build infrastructure and production facilities to develop and expand their targeted industries. This facilitates a more efficient deployment of financial resources globally. Fundamentally international capital flows are subject to changes in the fundamentals of countries and/or industries. The Euro crisis has definitely been one of the major events affecting the international capital flows in recent years. The huge debt crisis associated with Italy, Spain, Portugal and Greece and the sovereign credit rating downgrade of those EU countries (including Portugal to junk status in 2011 and Greece to default status upon its haircut of offshore bonds in early 2012) have led to huge losses in investor confidence in the EU and massive investor shifts of capital out of those countries. The EU banks and corporates have suffered from higher funding costs as a result. The past several years has also seen a gradual capital outflow from debt markets and inflow into equity markets. The economic slowdown of the developing markets, the quantitative easing (QE) tapering in the US and political uncertainty have also resulted in a capital outflow from the emerging markets in particular Brazil, Russia, India, China and South Africa (BRICS). However, experience in the last several years shows such capital flow can easily be affected by governmental economic policies. When the United States implemented three rounds of quantitative easing between 2008 and 2012, a huge amount of liquidity was injected into the banking system. While the original purpose was to allow banks to have ample funding at low cost and on-lend to corporate and individual borrowers to resume investment and consumption, a large part of the liquidity has in fact flowed to capital and real estate markets. The result is that a lot of bond issuers, including those in the high-yield rating categories, have been able to issue and/or refinance bonds at lower interest rates, and also there has been a surge in real estate prices globally. Similar quantitative easing measures by Japan and the European Central Bank (ECB) are expected to have similar impact on international capital flows, though the extent of the impact is not expected to be comparable to that of the US. Apart from governmental economic policies a change in sentiment towards particular countries and/or industries can impact the international capital flows. For instance, the political dispute in the eastern part of Ukraine since 2014 has led to sanctions by western counties against Russia in numerous areas, including the financial services provided to Russian companies and individuals, and hence major shutdown of funding sources for Russia. Another example is China's property sector, where China's economy has been slowing down and hence apartment sales, which provide the major funding for debt repayment by China property developers, have also slowed since 2013. Hence the sentiment towards the sector turns negative, which has led to a higher funding cost (in both loan and bond markets) for most property developers in China. 5. **Participants in the Global Financial System** Participants in the global financial system can generally be classified into the following: 8. **Banks** Banks play a very important role in the global financial system by channelling various financial resources from providers to users. In commercial banking banks perform origination and underwriting functions, to ensure that such financial resources from the depositors go to the right borrowers at the right interest rates, and banks take the credit risk in such lending. In investment banking banks market, the equity and fixed income securities of different issuers to various investors, and make commission in facilitating such transactions with the ultimate risks borne by the investors. 9. **Funds** Funds provide the major sources of capital in various segments of the financial system. Traditional equity and bond funds play an important role in shaping the price and trading volumes of various equity and fixed income securities in the capital markets. Nowadays funds play more active roles in participating in alternative asset classes like hedge funds, private equity funds and real estate funds, which are generally non-public and less liquid compared with capital markets. 10. **Credit rating agencies** Despite the criticism against the role of the major credit rating agencies in the global financial crisis of 2008 the three largest global credit rating agencies, namely Moody's, Standard & Poor's, and Fitch, still have a prominent role in affecting the debt funding costs of countries and companies with their ratings assigned and subsequent rating actions. Their role is particularly important, as most funds do not have in-hose credit functions large enough to cover global fixed income securities. 11. **Information providers** With advances in technology, in particular the Internet and mobile phones, banks and investors can easily be aware of the latest financial market news and pricing information, and global information providers like Bloomberg and Reuters etc. are crucial in providing detailed and real-time financial and market data to facilitate the functions performed by banks, funds and credit rating agencies. **\ ** 12. **Industry associations** These are important in two main aspects. Firstly, they facilitate banking and financial services industry development, by establishing and maintaining certain qualification examinations for practitioners, to ensure high and consistent standards. Secondly, they organise training and education seminars, to facilitate knowledge and experience transfer among practitioners. 13. **Government and regulators** Governments and regulators are increasingly playing an increasingly significant role in the global financial system, especially after 2008. More stringent regulations covering the activities of most of the other participants in the global financial system are in place, and they have substantially increased compliance costs and reduced profitability to market participants in the short to medium term, but hopefully expect to bring long-term stability and credibility to the global financial system. 14. **Supranational and multilateral agencies** Various supranational and multilateral agencies, including the World Bank (and International Finance Corporation), the International Monetary Fund (IMF), the Bank for International Settlements (BIS) and the Asian Development Bank (ADB), have been providing support to the global financial system through funding, guarantee and research help, particularly in emerging markets and countries experiencing distress. 2. **Money and Banking System** 6. **Supply of Money** 15. **Functions of money** There are basically four functions of money in the economy: - Unit of account: One dollar is the unit of account in which prices are quoted and accounting records are kept. - Medium of exchange: Money permits a time interval between buying and selling goods and services. Thus, it eliminates the need for a 'double coincidence of wants' implied by a bartering system, as people can sell goods and services without simultaneously purchasing. - Store of value: Money retains value over time. In this connection money also acts as a medium of exchange. - Standard of deferred payment: Loans and future payments are agreed and contracted in money terms, as money units are accepted as the means of settling future accounts. 16. **Characteristics of money** Further to the above functions of money, there are also several characteristics of money as listed below: - - - 17. **Categories of money** In general, a nation's money can be classified as: - M1: This consists of all bank notes and coins in circulation and demand deposits with licensed banks. It is also known as "narrow money". - M2: In addition to M1 this consists of savings and time deposit accounts with licensed banks. - M3: In addition to M2 this consists of deposits in financial institutions other than licensed banks. It is also known as "broad money". The above classification is generally applicable to many nations. While Hong Kong adopts a similar classification, there are some definition differences between Hong Kong and other countries. Firstly, instruments like repos and money market funds, which are included in money supply calculation in other countries, are excluded in Hong Kong due to their lack of liquidity. Besides most nations compile the money supply on a resident-holding basis, while Hong Kong does not. In addition, the government's deposit holdings are included in Hong Kong Dollar broad money, but they are excluded in other countries. Furthermore, Exchange Fund placements with a maturity over one month are counted as customer deposits, and thus included in money supply figures. 7. **Functions of Banking in the Financial System** 18. **Process of intermediation** An intermediation process involves third parties (namely financial institutions or intermediaries) acting as a link between lenders and borrowers of funds. Financial intermediaries are able to acquire funds from lenders and lend them to borrowers at a higher interest rate. In this process an intermediary has to assume a certain degree of financial risk, but making a return by way of interest difference, fees, commission and brokerage. 19. **Advantages of intermediation** There are basically five advantages to adopting financial intermediation: - - - - - 8. **The Global Banking Business** After the global financial crisis in 2008 the central banks in the U.S.A., the Euro zone and Japan implemented various quantitative easing measures, which injected a lot of liquidity to the banking system and expanded the asset size of most banks globally. While the ample liquidity benefited a lot of bank borrowers through lower debt funding costs, it further increased the already severe competition among banks for good borrowers at reasonable net interest margins. The global banking business has also seen the emergence of Asian banking forces. The European sovereign crisis and rating downgrades adversely affected credit ratings, funding costs and thus market competitiveness of the European banks in the global markets. Japanese banks like Bank of Tokyo Mitsubishi, Mizuho and Sumitomo Mitsui Banking Corporation have been leveraging their huge balance sheets with very low funding costs to rapidly expand in the offshore markets and have expanded their active client bases from serving the offshore subsidiaries of Japanese corporations to the major local corporations in each country. Australian and New Zealand banks like ANZ, National Australia Bank and Westpac, which did not aggressively expand before 2008 and thus avoid the losses associated with residential mortgage-backed securities and collateralized debt obligations in the US and Europe, were able to leverage their domestic profitability to fund overseas expansion. Basel III has a dramatic impact on banks' business model and funding sources. The regulatory shift towards a higher capital adequacy ratio means banks will gradually shift from capital intensive business like fixed income trading to more fee-based services like private banking. The regulatory shift towards a higher capital quality means that in the next several years banks will undertake more issues of equity securities and contingent convertible bonds with loss absorption features, in order to meet the "2019 capital requirements". Meanwhile, there are further implementations by the end of 2022 and within 2023, they are: i) Revised frameworks on credit risk, operational risk, output floor and leverage ratio; ii) Revised market and CVA risk frameworks; and iii) Revised disclosure framework[^1^](#fn1){#fnref1.footnote-ref}. Implementation of the Foreign Account Tax Compliance Act (FATCA) requiring 1) individuals who live outside the US to report their financial accounts held outside the US, and 2) foreign financial institutions to report to the Internal Revenue Service (IRS) about their U.S. clients, as well as the global regulatory effort towards more stringent anti-money laundering and anti-tax evasion among banks are likely to impact staffing and divert senior management attention to compliance matters and on-going dealing with governments on those matters. New York, London and Hong Kong have long been regarded as established financial centres in the world and have become a hub for banks to cover the respective regions in America, Europe and Middle East and Asia Pacific respectively. 9. **Central Banks** Central banks are the authorities managing a state\'s currency, money supply and interest rates. They also usually oversee and regulate the commercial banks in their jurisdictions. They can usually print their national currencies, and act as the lenders of last resorts. The primary functions of central banks include: 1. Conducting the country's monetary policy through interest and exchange rates. 2. Maintaining financial system stability and integrity by supporting banks in crisis or financial distress. 3. Supervising and regulating the banks through reserve requirements and capital adequacy ratios. Examples of central banks include the Federal Reserve (Fed) in the United States, the European Central Bank (ECB) in the Euro zone, the Bank of England (BOE) in the United Kingdom, the People's Bank of China (PBOC) in China, the Hong Kong Monetary Authority (HKMA) in Hong Kong, the Bank of Japan (BOJ) in Japan and the Monetary Authority of Singapore (MAS) in Singapore. Central banks are supposed to be independent from their governments, though this is not usually the case. For instance, Shinzo Abe, the prime minister of Japan, nominated Haruhiko Kuroda, who was a key supporter of monetary easing, to take over the BOJ governor role from Masaaki Shirakawa in 2013, in order to push forward his Abenomics based on the three pillars of fiscal stimulus, monetary easing and structural reform. In addition, the Bank for International Settlements (BIS) plays a significant role in fostering international monetary and financial cooperation among central banks globally. BIS issued a set of recommendations for regulators in the banking industry, including Basel I setting minimum capital requirements for banks with the primary focus on credit risk and risk weighting of assets in 1988, Basel II extending the capital adequacy standards cover credit, market and operational risks banks face in 2004, and Basel III, to be gradually implemented between 2013 and 2019, to further strengthen the nature and the amount of capital banks, as well as build in additional liquidity and leverage ratio to strengthen bank capital adequacy. 10. **The Bank Organisation** A bank can broadly be divided into two major divisions: front and back office. Front office departments deal with external clients and have the primary role of generating revenue for the bank, while back office departments support the front office and have only limited interaction with external clients. The front office of a bank usually includes the following departments: retail banking, commercial banking, investment banking, private banking and asset management. - - - - - - - - The back office of a bank usually includes, but is not limited to, the following departments: operations, information technology, finance, risk, human resources, compliance and legal. The 2008 global financial crisis and the more stringent banking regulations mean the risk and compliance departments are expanding and becoming more important parts of a bank. In addition to the front and back offices some banks adopt middle offices, which include product control and operation etc., and they are responsible for coordinating with the front offices and occasionally dealing with external parties, e.g., counterparty operation. In response to the fierce competition in the market some banks adopt different organizational structures to facilitate cross-selling and achieve cost efficiency. For instance, in 2014 Standard Chartered Bank integrated its wholesale and consumer banking into one group, in order to achieve more effective selling of a wide range of products to various customer bases and cut the overlap of the back office departments which used to separately support the wholesale and consumer banking departments. Senior management of a bank typically comprises a chief executive officer, a chief operating officer, a chief financial officer, a chief risk officer and a general counsel. The senior management team is overseen by a chairman, who represents the board of directors in ensuring that the management team is performing their duties in the best interests of the company and all relevant stakeholders. 11. **Banking and Financial Services in Hong Kong** The banking and financial services sector in Hong Kong follows international trends, and banks today sell a wide range of financial products other than traditional loans and deposits, such as securities dealing, insurance cover as well as investment and provident funds. The local regulatory environment is conducive to the development of such a universal banking model in Hong Kong. There are different regulators for different financial services, namely the Hong Kong Monetary Authority (HKMA) for banking, the Securities and Futures Commission (SFC) for securities dealing, the Insurance Authority (IA) for insurance as well as the Mandatory Provident Fund Scheme Authority (MPFA) for mandatory provident funds. Nevertheless, these regulators have signed memorandums of understanding (MoU) with the HKMA, thus recognizing it to be in a supervisory role, when banks engage in the provision of the relevant business. Hong Kong maintains a three-tier system of (i) licensed banks (LBs), (ii) restricted licence banks (RLBs) and (iii) deposit-taking companies (DTCs). Under the Banking Ordinance these are collectively referred to as "authorized institutions' (AIs). According to the Banking Ordinance the business of taking deposits may be carried out by AIs, while banking business may only be carried out by a bank. This means that as far as the business of taking deposits is concerned, only licensed bank may operate current and savings accounts and accept time deposits of any amount and maturity. On the other hand, RLBs and DTCs may only accept time deposits within the limits / ambit of the Banking Ordinance. **Minimum Capital** **Size and Terms of Deposits** ---------------- --------------------- ----------------------------------------------------------------- Licensed banks HK\$300 million Current, savings & time deposits of any amount & maturity RLBs HK\$100 million HK\$500,000 or more at any maturity. No savings accounts DTCs HK\$25 million HK\$100,000 or more for at least 3 months. No savings accounts. As of 30 September 2022, there were a total of 183 AIs in Hong Kong, comprising[^2^](#fn2){#fnref2.footnote-ref}: **HK-incorporated** **Incorporated outside HK** **Total** ---------------- ------------------------------ ----------------------------- ----------- Licensed banks 31 (Including virtual banks) 125 156 RLBs 10 5 15 DTCs 12 0 12 Examples of restricted licensed banks: Goldman Sachs Asia Bank Limited, J.P. Morgan Securities (Asia Pacific) Limited, Nippon Wealth Limited, etc. Examples of deposit-taking companies: Fubon Credit (Hong Kong) Limited, Public Finance Limited, etc. HKMA maintains a register of the names and principal places of business of all AIs. Apart from banks engaging in the provision of non-traditional banking services there is cross-selling of other financial products and services. For example, life insurers sell insurance schemes with investment elements that resemble regular investment plans provided by mutual funds or unit trusts. There are also non-banks providing loans to customers, so for example there are a lot of non-bank consumer finance companies and property developers providing second mortgages for new flat purchase in addition to the lending provided by banks. Nevertheless, it is more common for banks to extend other financial services, but it is not common for other financial services providers to offer banking services. This is because only banks, or formally speaking, institutions authorized by the HKMA can engage in the business of deposit taking and provision of checking accounts. Therefore, while banks provide non-bank financial services, it is rare for other financial service providers to engage in banking services. Regarding service delivery, Hong Kong banks also engage in various electronic delivery channels, to provide services to customers in addition to the traditional branch network. Phone banking, Internet banking and mobile phone banking are common for customers to obtain information, check balances and manage their accounts. Renminbi (RMB) business in Hong Kong was first launched in 2004, enabling Hong Kong banks to provide personal RMB business, and it has since been continually expanded. With the introduction of the pilot scheme for RMB trade settlement in July 2009 and its expansion commencing July 2010, banks participating in RMB business in Hong Kong may offer a wide range of RMB services to their corporate customers, including trade finance, RMB certificate of deposits, RMB bonds and other related products and services. The global financial crisis of 2008 not only affected US and European banks, but also Hong Kong banks. Bank of East Asia experienced a bank run in September 2008 and then announced a loss of HKD3.3 billion due to collateralised debt obligation (CDO) carrying value write-down in October 2008. Also, the huge investor loss on various structured products including accumulators and Lehman minibonds raised a lot of public concern about the regulatory inadequacy in the sale of those products. Since then, HKMA has issued a number of circulars covering the rules and guidelines on both the selling processes and the sale of certain financial products. Banks in Hong Kong have also experienced profound consolidation with some major and large-scale merger and acquisitions during the past decade or so. In a way similar to the global trend, these consolidations involved both functional and geographical consolidation, and as a result several large banking groups emerged in the market that are capable of providing a wide range of services that cover banking, securities and insurance. For example, Yue Xiu Financial Holdings, a wholly owned subsidiary of Guangzhou Yue Xiu Holdings, acquired 75% of Chong Hing Bank, a Hong Kong incorporated Bank, in February 2014. OCBC, one of the big three banks in Singapore, acquired and delisted Wing Hang Bank, a Hong Kong incorporated bank, in July 2014. Chinese banks like Bank of Communications and China Minsheng Bank adopted organic growth models and established branches in Hong Kong. Banks like China Merchants Bank adopted a hybrid approach of having a branch in Hong Kong, while acquiring Wing Lung Bank to expand its Hong Kong footprint. As a result, the Hong Kong banking industry is highly competitive, and tremendous attention is paid to the provision of a full range of corporate and personal financial services. To cope with the competitive environment, a lot of new products and innovative products emerged. Given the declining net interest margin and the increasing capital associated with trading activities, banks have been turning more attention to fee-based services and have expanded their presence in wealth management and private banking services accordingly. By the end of September 2022, there are 8 virtual banks have been approved by HKMA as licensed banks. The launch of virtual banks is a key step of the Smart Banking Initiatives, which will cultivate financial innovation, enhanced customer experience and financial inclusion, as said by Mr Norman Chan, ex-Chief Executive of the HKMA.[^3^](#fn3){#fnref3.footnote-ref} In order to promote green and sustainable banking, the Cross-Agency Steering Group, co-chaired by the HKMA and the SFC, announced launch of information and data repositories and reported other progress in advancing Hong Kong's green and sustainable finance development in June 2022, and help the financial ecosystem's transition towards carbon neutrality.[^4^](#fn4){#fnref4.footnote-ref} 12. **Banking and Financial Services Industry in China** China's economic growth in the past twenty years has led to significant growth of the banking and finance industry. The banking and financial services industry was regulated by the People's Bank of China (PBOC), the central bank, China Banking Regulatory Commission (CBRC), which oversees the operations of all banking institutions in China and the State Administration of Foreign Exchange (SAFE), which supervises and monitors foreign exchange transactions. Banks are also subject to regulation by China Securities Regulatory Commission (CSRC) and China Insurance Regulatory Commission (CIRC) for businesses in securities and futures markets and insurance respectively. On 8^th^ of April 2018, China Banking Regulatory Commission (CBRC) and China Insurance Regulatory Commission (CIRC) merged into a new entity for monitoring both the banking and insurance industry. China Banking and Insurance Regulatory Commission (CBIRC) is primarily responsible for: - Supervising the establishment and ongoing business activities of banking and insurance institutions. - Taking enforcement actions against regulatory violations. The major commercial banks in China are stated-owned, including Industrial and Commercial Bank of China (ICBC), China Construction Bank (CCB), Bank of China (BOC), Agricultural Bank of China (ABC), Bank of Communications and Postal Saving Bank of China (PSBC). In addition, there are joint-stock commercial banks including China CITIC Bank, China Merchant Bank and China Minsheng Bank. All these banks not only have significant market presence in the domestic markets in China but are also aggressively expanding in the offshore markets, utilizing Hong Kong as a base for non-China banking businesses. They are also listed on major stock markets including Hong Kong, to diversify their funding channels and enhanced their market profiles. In addition, there are policy banks like China Development Bank and The Export-Import Bank of China to provide support to infrastructure and trade finance respectively. On the products front, since the restructuring of its banking sector, China has set new directions for its banks to operate with a market-oriented business model and to allocate resources more efficiently. This has resulted in rapid development of consumer and private enterprise credits, such as mortgage loans, car loans, credit cards, and commercial loans to enterprises. On the other hand, due to growth in personal wealth there is an emerging need for personal investment products. This is evidenced by strong growth in the local stock market and hence stock brokering services as well as the rise of insurance products. Moreover, Chinese banks are also employing multiple electronic delivery channels to deliver their services to clients as their foreign counterparts do. In addition, most of these banks adopt universal banking models, by expanding investment banking and private banking services. One major development in China's banking and finance industry is the liberalization of interest rates. In the past banks needed to charge a minimum interest rate on their lending, and a maximum interest rate banks they had to pay on deposits received. This regulatory floor and cap allowed the China banks to make a high net interest margin (NIM) and allowed banks to lend to the state-owned enterprises at low interest rates. In July 2013 the PBOC removed the lending-rate floor for financial institutions and the lending-rate cap on rural credit cooperatives. This and the future ongoing liberalization in interest rates may put pressure on banks' NIM and hence profitability but will allow more accurate pricing of loans to borrowers, and hence better financial resource allocation. The rapid expansion of shadow banking, which is a credit intermediation outside the official banking sector, has increasingly caught the market attention. Shadow banks typically include unlicensed and ungoverned credit intermediaries (e.g., internet financial companies), unlicensed credit intermediaries without sufficient governance (including financing guarantee companies, micro loans companies) and licensed financial institutions with business not fully governed or deemed to engage in regulatory arbitrage (including money market funds, asset securitization and wealth management products). As the shadow banking financing volume is large and developing very quickly, the regulators have recognized the scale and risks associated with the shadow banking system and have been imposing regulations to stop credit growth though this non-official credit channel. On the other hand, internet financing has become a popular topic in the past two years. Entry of e-commerce and internet companies e.g., Alibaba into the financial sector, and the migration of traditional financial services to the internet have been driving the growth of internet financing in China. Internet finance products include third-party payment, online financial and wealth management, P2P loans (i.e., person-to-person loans), online insurance and online financial platforms. While this may be viewed as a threat to the traditional banking system in terms of sourcing deposits and product innovation, this has the positive effect of pushing the banks to further leverage the use of the internet platform to expand market outreach. So far there have not been any concrete regulations governing internet finance, and market participants are anticipating CBRC will draft the relevant rules in the near future. Lastly, the development of the Guangdong-Hong Kong-Macao Greater Bay Area (Greater Bay Area) has achieved a key strategic planning in the country. One of the important achievements was the announcement of the Memorandum of Understanding on supervisory cooperation under the Cross-boundary Wealth Management Connect on 5th Feb 2021, more cooperation between the market participants in the Greater Bay Area could be expected. While the Cross-boundary Wealth Management Connect Scheme was launched in September 2021, allowing eligible Mainland, Hong Kong and Macao residents in the Guangdong-Hong Kong-Macao Greater Bay Area ("GBA") to invest in wealth management products distributed by banks in each other's market through a closed-loop funds flow channel established between their respective banking systems. A major breakthrough of the Cross-boundary WMC is the considerable degree of flexibility given to individual retail investors to open and operate cross-boundary investment accounts directly, through a formal and convenient channel, and to choose their preferred products.[^5^](#fn5){#fnref5.footnote-ref} 3. **Chapter Summary** - Household, business, government and overseas sectors demand and supply different products and services in an economy. - Participants in the global financial system include banks, funds, credit rating agencies, information providers, industry associations, governments and regulators and supranational and multilateral agencies. - Money serves the function of unit of account, medium of exchange, store of value and standard for deferred payment. - Basel III and FATCA have dramatically affected global banking business. - Central banks are the authorities managing a state's currency, money supply and interest rates. - A bank organization typically comprises front offices dealing with external clients and generating revenue and back offices supporting the front offices. - The latest development of the banking and financial services industry in Hong Kong includes more stringent banking regulation, expansion of RMB businesses and acquisition of Hong Kong incorporated banks by overseas companies. - The latest development of the banking and financial services industry in China includes commercial bank expansion into investment banking businesses, interest rate liberalization, shadow banking expansion and Internet financing. - 4. **Reference Summary** - Mishkin, Frederic S. (2012) Economics of Money, Banking and Financial Markets, 10th Edition, Prentice Hall - HKMA Background Brief No. 2 Banking Supervision in Hong Kong, Second Edition 2012, HKMA - Banking in China, Second Edition 2011, Palgrave Macmillan 5. **Review Questions** 1. Which of the following economic sectors demand and supply different products and services? A. Household sector B. Business sector C. Government sector D. All of the above 2. What is the original purpose of a central bank conducting quantitative easing? A. To inject liquidity into the banking system to stimulate investment and consumption B. To push up the real estate price C. To push up the stock market index D. All of the above 3. Which of the following is not a participant in the global financial system? A. Non-profit organisations B. Banks C. Credit rating agencies D. Governments and regulators 4. Which of the following is known as "broad money"? A. M1 B. M2 C. M3 D. None of the above 5. Which of the following is not an advantage for a financial intermediation? A. Risk transfer B. Yield enhancement C. Economies of scale D. Increasing liquidity **Answers:** 1\. D 2\. A 3\. A 4\. C 5\. B ::: {.section.footnotes} ------------------------------------------------------------------------ 1. ::: {#fn1} Revised Basel III implementation timeline, 12 June 2021 by HKMA. https://www.hkma.gov.hk/media/eng/doc/key-information/guidelines-and-circular/2021/20210610e1.pdf[↩](#fnref1){.footnote-back} ::: 2. ::: {#fn2} [↩](#fnref2){.footnote-back} ::: 3. ::: {#fn3} Granting of virtual banking licences, HKMA, 2019. https://www.hkma.gov.hk/eng/news-and-media/press-releases/2019/05/20190509-3/[↩](#fnref3){.footnote-back} ::: 4. ::: {#fn4} Cross-Agency Steering Group announces launch of information and data repositories and other progress in advancing Hong Kong's green and sustainable finance development, HKMA, 2022. https://www.hkma.gov.hk/eng/news-and-media/press-releases/2022/06/20220621-5/[↩](#fnref4){.footnote-back} ::: 5. ::: {#fn5} https://www.hkma.gov.hk/eng/key-functions/international-financial-centre/wealth-management-connect/[↩](#fnref5){.footnote-back} ::: :::