J O U R N A L O F T H E H O N G K O N G I N S T I T U T E O F B A N K E R S

Jul ﹣ Aug 2013 Issue No.71

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Small Loans Can BeBeautiful: Microfinance

in Hong Kong

China’s Banks Advance into the Digital World

Navigating the Global Financial Crisis

Mongolia’s Banks are Growing Up

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02 Cover Story Small Loans Can Be Beautiful: Microfinance in Hong Kong

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12 China World China’s Banks Advance into the Digital World

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20 Global Eye Navigating the Global Financial Crisis

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27 Regional Banking Mongolia’s Banks are Growing Up

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34 Financial Regulation Creating Wealth in Emerging Markets

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40 Talk Around Town The Man Who Designs the Notes

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46 HKIB News The Latest Happenings

2 Cover STORY

Small Loans Can Be Beautiful:

Microfi nance in Hong Kong

.

Jul-Aug 2013 3

While microfinance

originated from the world’s

developing countries,

a number of developed

countries have also set up

microfinance schemes in

recent years. One of these

is Hong Kong. During this

time, the developed-nations’

microfinance schemes

have already found certain

levels of success.

Hong Kong is one of the several developed economies in Asia

that has initiated a microfi nance scheme to help strengthen its social capital. In June 2012, the Hong Kong Mortgage Corporation Limited (HKMC), chaired by the Financial Secretary John Tsang, launched a pilot microfi nance scheme in collaboration with banks and non-governmental organisations (NGOs) to provide both microfi nance loans and entrepreneurial support to the local small businesses.

The Beginning of Microfinance Schemes Microfi nance has its origins in developing countries such as Bangladesh and India, where their huge rural populations often have either no or limited access to formal banking services. It generally refers to the provision of micro-loans to individuals who have diffi culties in accessing traditional bank credit. It usually helps these individuals to start their own businesses or receive self-enhancement training.

Microfi nance generally started with voluntary agencies helping underprivileged groups who tend to be socially or fi nancially excluded. Examples include: women, youths, unemployed and new migrants. The voluntary agencies would set up microfi nance schemes to provide fi nancial support or services in the form of grants or loans to their target groups. Over time, some microfi nance lenders in developing countries have transformed from not-for-profi t organisations into commercial lenders; for example, Banco Compartamos in Mexico and SKS Microfi nance in India.

As the fi nancial systems in developing countries are usually underdeveloped and many disadvantaged borrowers have diffi culty in accessing the traditional banking system, there are niche markets available for microfi nance institutions to close the substantial fi nancing gap that was not being satisfi ed by traditional banks. In contrast, the fi nancial systems in developed economies are usually more sophisticated and the fi nancing gap is usually narrow, so there are generally less groups of people who are fi nancially excluded.

Small Loans Can Be Beautiful:

Microfi nance in Hong Kong

4 Cover STORY

Microfinance Schemes in Developing CountriesIn general, microfinance schemes found in developing economies have a relatively large number of borrowers who are mainly low-income people, in particular women. Group lending is common, i.e. lending to a group of borrowers with collective and joint responsibility to repay the debt obligations. Loan amounts are generally small; it is not uncommon for loan amounts equivalent to a few hundred or a few thousand Hong Kong dollars. The interest rates are also generally high; the rates are often in double-digit figures, and can be as high as 85% per annum. With group lending, borrower group self-assessment is usually used and a guarantee by the group is required. Training and mentoring services are made available and the lending institutions can be banks or voluntary agencies.

In addition, staff costs are usually low which makes the overall operating cost of commercial microfinance schemes in developing countries significantly lower than in developed countries, and lenders can undertake more labour-intensive marketing and loan servicing activities.

Microfinance Schemes in Developed CountriesCompared with schemes in developing countries, microfinance in developed economies caters for a narrower range of borrowers. This is because developed economies generally have more employment and business opportunities. Financially excluded individuals, micro-enterprises and low-income groups, such as the unemployed or immigrants, are the main customers for loans. Lending is usually on an individual basis. Loan amounts are significantly larger than in developing countries’ microfinance schemes, equivalent to between tens of thousands and a hundred thousand Hong Kong dollars. The interest rates are broadly between single-digit and low double-digit figures, which are generally lower than in developing countries. Vetting relies on business-plan evaluation, credit record, credit scoring and/or panel interview. Mentoring services are available and mentors are usually from the commercial sector. Funding of the schemes comes mainly from banks, government and/or voluntary agencies.

For example, Association Pour le Droit a I’Initiative Economique (ADIE) is an NGO in France that offers a microfinance scheme for unemployed individuals

who wish to start up their own businesses. It obtains low-cost loans from banks and credit guarantee from the European Investment Fund to fund its scheme. Another example is MicroBank in Spain, which was established by a commercial bank as a specialised unit in microfinance. It specialises in lending to micro enterprises with less than 10 employees and annual turnover less than EUR500,000 and entrepreneurs and self-employed persons with income less than EUR60,000 to start up, consolidate or expand their businesses. Apart from the capital provided by its parent company, MicroBank also has a loan facility from the Council of Europe Development Bank and receives credit guarantees from the European Investment Fund to fund its microfinance loans.

In Southeast Asia, Singapore launched a microfinance scheme in 2011. The scheme is funded by the Singapore Totalisator Board (an organisation similar to The Hong Kong Jockey Club in Hong Kong) to provide loans to Singaporeans aged 18 or above with gross annual income not more than S$30,000 per annum. The purpose of the loans is to help borrowers to start-up new small businesses or to expand existing small businesses that are managed and operated by the borrowers. In Taiwan, the government launched a number of microfinance schemes to provide loans to Taiwanese aged between 20 and 65 to start-up new businesses or to support existing businesses. The loans are provided by either financial institutions, or government and financial institutions jointly.

Study of the Microfinance Scheme in Hong KongIn view of successful microfinance schemes overseas in assisting business start-ups and boosting employment,

Jul-Aug 2013 5

the Financial Secretary in Hong Kong commissioned the HKMC to carry out a feasibility study on the introduction of microfinance in Hong Kong in 2011. Hence, the HKMC formed its Microfinance Study Group in March 2011 to carrying out the study.

The Study Group examined the feasibility of introducing a sustainable microfinance scheme in Hong Kong through the identification of potential demand, critical success factors, an appropriate business model and implementation issues. It conducted gap analysis, literature survey of authoritative documents on microfinance, study of overseas microfinance schemes, interviews with local agencies operating similar schemes, focus group meetings with potential microfinance users and consultation with relevant experts in the field. In its focus group meetings with voluntary agencies and young entrepreneurs, there were plenty of examples of unmet demands for microfinance, and three potential market segments for microfinance were identified:

1. micro-entrepreneurs during business start-up stage and initial operating stage;

2. self-employed individuals; and 3. individuals who wish to pursue self-enhancement

for skills upgrading or acquiring a recognised qualification or diploma.

The HKMC submitted the Study Group’s report to the Financial Secretary in August 2011 and recommended to carry out a sustainable microfinance pilot scheme based on five guiding principles:

1. the scheme should be self-sustaining in the long-run;

2. the scheme should not be operated as a social

welfare hand-out;3. the borrowers must have the willingness to repay

the loans;4. the borrowers will need to present viable

business plans for micro-business start-ups and self-employment; and

5. the borrowers should have the ability to implement the business plan.

Introducing the Microfinance Scheme in Hong KongAs part of Government’s strategy to strengthen the social capital in Hong Kong, the Financial Secretary in early 2012 commissioned the HKMC to introduce a microfinance pilot scheme after considering the Study Group report. The pilot scheme would run on a self-financing basis with a tentative aggregate loan amount of HK$100 million for a three-year trial period.

Subsequently, the HKMC launched the Microfinance Scheme in June 2012, in collaboration with six banks and five NGOs, to provide not only micro loans but also supporting services such as mentoring and entrepreneurial training to the borrowers.

The banks and NGOs participating in the scheme include Bank of China (Hong Kong), Bank of Communications Hong Kong Branch, Bank of East Asia, Citibank Hong Kong, Nanyang Commercial Bank and Wing Lung Bank, and HKSKH Lady MacLehose Centre, Hong Kong Young Women’s Christian Association, The Hong Kong Federation of Youth Groups, The Society of Rehabilitation and Crime Prevention, Hong Kong and YMCA of Hong Kong. The scheme offers three types of loans, namely Micro Business Start-up Loan, Self-employment Loan and Self-enhancement Loan. The respective target borrowers are business starters, self-employed persons and people who wish to receive training, enhance their skills or obtain professional qualifications for self-improvement, but cannot do so through the traditional banking channels.

The maximum loan amount of the three types of loans is HK$300,000, HK$200,000 and HK$100,000 respectively. The repayment period is up to five years. The interest rate is not more than 9% per annum (p.a.) for general borrowers and not more than 8% p.a. for

borrowers who can provide a third-party guarantee. The Microfinance Scheme provides the borrowers with up to 12 months’ principal repayment holiday, so as to lessen the repayment burden at the initial stage of their businesses.

For applicants of the Micro Business Start-up Loan and the Self Employment Loan, they will have to submit their business plans to the HKMC. They will be invited to attend a vetting panel interview with representatives from the HKMC, banks, NGOs and other professionals with relevant experience. During the interview, the applicants will be required to present their business plans and answer questions from the vetting panel. The vetting panel will then make recommendations to the HKMC on the loan applications based on the viability of the business plans and creditworthiness.

Mentor Support and Entrepreneurial TrainingThe key characteristics that distinguish the Microfinance Scheme from other traditional bank loans are the mentoring support and entrepreneurial training that borrowers receive.

The HKMC liaises with different trade organisations, chambers, professional bodies and NGOs to invite experienced business entrepreneurs, business professionals and industry veterans from various backgrounds to be the mentors for the borrowers. So far, there have been over 80 mentors who come from different industries, such as IT, law, accounting and catering, and so on.

The mentors will provide advice on preparing a business plan, and share their experience of running a business with the borrowers. Such advice and support could help them to think through their business ideas and improve the chances for their business plans to succeed. The mentors may also be invited to attend the vetting panel interviews to help assess the microfinance applications.

On the other hand, to help ensure the business-starter applicants are well-prepared to set up their new business, they may be required to complete relevant entrepreneurial training, and the NGOs can help refer them to attend the appropriate entrepreneurial training courses. However, exemption may be given to those who are university graduates or have entrepreneurial experience for at least two years.

The Market Response Between the launch of the Microfinance Scheme in June 2012 and the end of May 2013, the HKMC has received 118 applications, of which 72 cases have been approved with the total loan amount exceeding HK$19 million. The approval rate of vetted applications is around 70%.

Although the application volume is not overwhelming, the scheme has proven successful in helping some socially less privileged people to start their own businesses; for example, ex-bankrupts, ethnic minorities, ex-offenders, and so on. It has also helped some middle-aged people to make a career change and some aspiring young people to turn their creative ideas into real businesses. Currently, about half of the borrowers are aged 35 or below.

The borrowers have used the microfinance loans for a variety of businesses, such as coffee shop, snack shop, IT apps development, food waste management, photography services and fashion wholesales.

In general, the borrowers have given very positive feedback to the Microfinance Scheme. They particularly welcome the repayment holiday of the microfinance loans, which the traditional bank loans do not offer. This helps reduce the financial burden on the business starters when their businesses are still at an initial stage. Also, some borrowers appreciate that the requirement of submitting a detailed business plan for application has made them ponder about the viability and execution of their business ideas more thoroughly. This also helps them to pay more attention to finance and accounting, which is crucial to running a start-up successfully.

THE HONG KONG MORTGAGE CORPORATION LIMITED

Outlook for the US Economy

6 Cover STORY

Jul-Aug 2013 7

The Hong Kong Microfinance Scheme in Detail

* Borrowers are required to repay interest only during the principal repayment holiday

Micro Business Start-up loan

Self-employment loan Self-enhancement loan

Applicants/Guarantors(if applicable)

• Individual aged 18 or above and holder of a Hong Kong Identity Card (with the right of abode, right to land or right to stay in Hong Kong without restrictions) or a One-way Permit

• Not subject to any bankruptcy order or proceedings at the time of applicationRelevant Requirements

• Business may be conducted in the form of sole-proprietorship, partnership or limited company incorporated in Hong Kong

• If the business is owned by more than one person, all business owners must be co-borrowers (a maximum of two borrowers in one application).

The course should be related to a business start-up or career development. Eligible courses/examinations include:

1. Courses which are eligible for a grant or loan from the Student Financial Assistance Agency (SFAA) or funded by the Employees Retraining Board (ERB) but are not or have not been fully subsidised by the SFAA or ERB;

2. Accredited by the Hong Kong Council for Accreditation of Academic and Vocational Qualifications;

3. Professional examinations administrated by the Hong Kong Examinations and Assessment Authority; and

4. Any other courses or examinations will require approval from the HKMC

For the purpose of establishing a new business or conducting an existing business that has been established for less than five years (counting from the date of the first business registration)

For conducting a business for self-employment

Maximum Loan Amount

HK$300,000 HK$200,000 HK$100,000 or up to 100% of the training course/examination fee (after deduction of any government/SFAA or ERB subsidy), whichever is lower

Interest Rate Not higher than 9% per annum, or 8% per annum if a satisfactory third-party guarantee is provided

Maximum Loan Tenor

Five years

Repayment Arrangement*

• First three months principal repayment holiday for loan tenor of one year• First six months principal repayment holiday for loan tenor of two and three

years• First 12 months principal repayment holiday for loan tenor of four and five years

8

Jul-Aug 2013 9

10

Jul-Aug 2013 11

*

•

•

• •

1.

2.

3. 4.

• • •

12 China WORLD

With 538 million internet users in China, representing 38.9% of the mainland’s 1.34

billion population, and 388 million with mobile access to the internet, according to the China Internet Network Information Center’s latest fi gures from June last year, China’s banks have plenty of incentives to increase their presence in the online world.

They are not alone. Indeed, banks around the world have continued to make substantial investments in mobile and online projects, according to a recent Gartner report on the top global banks’ information technology (IT) investments, with the most notable initiatives in 2012 focusing on mobile and tablet banking, security and infrastructure.

Of the 216 major IT initiatives and investments announced by global banks during 2012 that Gartner identifi ed, 23 were by large Chinese banks. The initiatives included: Agricultural Bank of China’s launch of its new mobile fi nancial products brand “Golden Online: Smart e-Palm”, Bank of China’s partnership agreement with Monitise Asia Pacifi c’s Hong Kong business to investigate new ways for making payments with mobile phones, and the Industrial & Commercial Bank of China’s (ICBC Group) announcement that its fourth-generation core information system had gone live (more on this below).

China’s large banks are being compelled to upgrade their IT infrastructures and offer new mobile and online services not only to take advantage of the opportunities in China’s growing online market, but also to catch up with developments being made in overseas markets and ward off competition from non-fi nancial services providers, such as Taobao and 360Buy, which are considering providing fi nancial services on their online platforms, says David Furlonger, Vice President and Fellow of Gartner.

“360Buy.com, which is a huge internet player, has just acquired a domain name that stands for ‘online

banking’,” says Furlonger. “It is only a domain name at present, but one would assume that they are going to take their e-commerce business and look to go into online banking and payments.”

However, while e-commerce businesses in China may soon be encroaching on the banks’ traditional space, there is also evidence that some Chinese banks are looking to make inroads into e-commerce territory.

“The banks are almost going head-to-head with the internet portals. It is more usual that you fi nd banks forming links with some of the big e-commerce portals,” Furlonger says. “It appears that some such as Buy.ccb.com [developed by China Construction Bank] are looking to launch their own e-commerce portal for hosting any kind of service and goods sale. That is an interesting step beyond what you would imagine banks to do, which would be to go after the payments business from an e-commerce portal.”

If the mainland banks were to make a signifi cant move into e-commerce, it would be a world fi rst. We have not seen a bank in the western markets launch an e-commerce platform, Furlonger says.

China’s Banks Advance into the Digital World

Jul-Aug 2013 13

Mobile InitiativesIn the mobile banking arena, the mainland banks are making significant advances, according to a report by Deloitte released last year on banking trends in China. At the end of October 2011, the number of cell phone users in China had reached 964 million, and over 11% of these were 3G users. In addition, upgraded speed and improved quality with regard to mobile internet transmission meant that there is now a sound foundation on which to build mobile banking. In 2011, the number of users of mobile banking in China had exceeded 70 million, representing nearly 45% of the total mobile banking users around the world, Deloitte reported.

“With the continuous expansion of the user population in China and the increasing demand for mobile financial channels, coupled with the urgent need of traditional banks to adopt new delivery options, mobile banking is poised for growth,” the Deloitte report noted. “The integration of more financial services has become one of the focal points for next generation commercial banks.”

By June 2011, almost all of the major banks in the mainland had already rolled out WAP (wireless

application protocol) versions of mobile banking, the next generation of mobile banking services after SMS (short message service) banking. However to date, most of the advances made in the mobile banking space by mainland banks has been in personal banking services. Looking ahead, Deloitte expects there will be more developments in mobile banking services catering for small and medium-size enterprises. The high customer value and large demand of business customers on the mainland, Deloitte predicted, would provide a catalyst for business mobile banking initiatives, such as offering account inquiries, payments, settlements, investments and financing. These would be particularly appealing in a workplace environment that was trending towards mobile offices, Deloitte concluded.

Opportunities for GrowthWhile growth in China’s internet and mobile banking has been substantial to date, there are still many opportunities to continue expanding, Furlonger says. “There are quite a significant number of people online but there is a much lesser percentage who are doing online banking, particularly in the rural markets,” he says. “There is a concern in the Chinese market that a lot of income has been generated through personal mortgages, but there is a lack of liquidity and credit going to the small and medium-size enterprises.”

Some of the most significant innovations he expects Chinese banks to make in the near future will be in the area of verification of customers’ identities with the use of biometric techniques, such as palm readers for ATM machines. “It is in the banks’ interests because in the Chinese market, which traditionally has been a very physical environment with customers going into a branch and waiting in line, we are now seeing more people going online. But how do we know this is the correct person when you might not even see them? The customers will have a virtual identity that somehow the banks will need to verify, and it becomes a question of finding the best low-intrusive way of performing that verification. For some it might be voice recognition, for others it might be with finger or palm prints, or eye scans, and so on. They have to figure that out.”

Another area that banks will need to develop is in

14 China WORLD

gaining a greater understanding of their customers’ habits and behaviours. This is an area where the established e-commerce players have a distinct advantage, Furlonger says.

“E-commerce providers, particularly the likes of Taobao, have invested large amounts of money in CRM [customer relationship management] technology to try to understand what the customers are buying and why they are buying them. They have huge quantities of information about the customers in terms of their spending habits, kinds of things they are buying, how they pay, and so on. The banks would love to have that kind of knowledge,” Furlonger says. “The opportunities are still vast if the banks can develop much stronger and different kinds of analytics capabilities, re-think their approaches to risk and deal with investments, and move the CIO [Chief Information Officer] role to accept more of the business side of understanding communication and work with partners. They will have to adjust their mindset and thinking.”

Mainland banks, similar to many in the western world, have shown a great tendency to launch new IT initiatives – such as mobile payments, mobile banking and e-wallet services – without a sophisticated method for analyzing and determining how those products will be used by the customers, and the amount of variance in use there may be from one customer to the next, Furlonger believes.

“That knowledge will inform the price of the services they are offering, the risk management decisions they are making, and the partnerships they are form in order to give services that will make customers ‘sticky’ to their environment,” he says.

“The banks in China tend to be product-focused. They will need to consider what the use-cases are if they are going to be successful in acquiring and retaining what are increasingly fickle customers in the digital environment,” he concludes.

BRUCE ANDREWSGeneral Editor

ICBC Group has taken significant steps to move to the cyberworld by

expanding its internet banking platform.Nearly 50% of ICBC’s retail customers in mainland China currently use its personal internet banking service, and nearly 70% of ICBC corporate clients use the bank’s corporate internet banking service. ICBC has also built a network of 15,000 self-service banking kiosks in China, 115,000 self-service devices and over 950,000 point-of-sale devices. Last year, more than 37 billion transactions were made online amounting to 333 trillion yuan. Today, three out of every four transactions accepted by ICBC are processed online.

Earlier in 2013, Industrial and Commercial Bank of China (Asia) Limited, ICBC (Asia), the banking arm of ICBC Group licensed in Hong Kong, launched its new platform for internet banking services and mobile banking services.

The new services allow the bank’s customers to design their own internet banking interface they use according to their interests and habits. For instance, they can change the colour of the interface, and arrange their frequently-used functions on their welcome page or through an “express e-channel”. They can also create and terminate auto-payments to their credit cards, and transfer funds of Hong Kong and United States currencies to ICBC accounts in other countries, among about 70 other new features. In addition to an increase in number of functions and features, the internet services are now offering a higher processing speed and an enhanced safety standard for users.

Case Study: The new ICBC (Asia) Internet Banking Services Platform

Jul-Aug 2013 15

The new internet banking services are based on the FOVA system platform, which was developed by the bank’s parent, ICBC Group. ICBA (Asia) has been in the process of rolling out the FOVA system as an integrated global platform for the bank since April 2012. With more than eight million internet banking accounts in Hong Kong and online transactions reaching approximately HK$4 trillion per month on average, the special administrative region was seen as the logical choice for the mainland bank to begin extending its online global reach. The service will also be extended to other countries in future.

From Conception to DevelopmentBefore the new internet banking services were developed, there was a perception among the staff that customers were looking for a more convenient and stable platform than they were being offered. The project team conducted research and analysis into their existing customers’ needs to confirm their premises before proceeding to development. One of their most significant they found was that customers said would like the ability to customise their online banking interface.

The project was a collaborative effort between ICBC Group and ICBC (Asia). It was jointly led by the two parties with a Project Management Office that was composed of a business analyst, systems consultant, products team and technical experts.

There were some significant challenges that needed to be overcome before the project was completed, such as a very tight schedule for the system’s launch. As the project had an outsourcing arrangement, it also needed to gain the approval of an independent auditor’s assessment.

Extensive testing was required to complete the project. Penetration and migration testing were undertaken

to ensure the system’s capacity, security, user acceptance and disaster recovery were assured. Penetration testing allows the system to undergo tests for how it copes with simulated attacks from external and internal threats; migration testing is required before moving data from an old database to a new one.

After the LaunchLooking back over the project, the promotional campaign was launched in early March 2013, ICBC (Asia) learned several lessons. It was found that a good system is based on a detailed and clear specification of the users’ requirements. Also, technology projects must have a sufficient level of testing under both typical and atypical user conditions.

Furthermore, close communication between users and the project team members are vitally important. In order to further understand the procedures and the problems which might affect customers, users and the project team members have to discuss the project thoroughly in order to minimize errors and also increase efficiency when solving problems.

Overall, the launch of the new internet banking services represent a further step for ICBC Group to integrate its global platform with its core business. Looking ahead, it is understood that in planning for the next round of new applications, ICBC will continue following the “blueprint” that has been set for building the next generation of architecture for its information technology systems. The next step will be to apply the FOVA-based systems to offshore markets.

LI YIQIHead of Electronic Banking DepartmentICBC (Asia)

16

Jul-Aug 2013 17

1818

20 Global EYE

When the fi nancial crisis of 2007-08 hit, it was already too late for many banks

and fi nancial institutions to use short-term measures to defend themselves. Some failed, but others managed to survive and navigate through the crisis.

As a member of the staff of the United States government’s Financial Crisis Inquiry Commission, the author of this article gained a unique perspective on the institutions that failed and those that survived, and what those two groups did differently during the crisis.

In 2010, the commission interviewed chief executives, bankers, risk offi cers, board members, regulators and policy makers to try to understand what happened. The debacle was fresh enough in peoples’ minds that they really were eager at that point to share their stories.

Throughout the investigation, the objective was to discover the answer to the following question: What was the difference between companies that successfully navigated the crisis and companies that did not?

The companies that did well had a combination of excellent information fl ow from the bottom of the company to the top, and from across the company, to the decision makers.

Ultimately, it was the quality of decision-making that turned out to be the core issue. Companies that made decisions well had a process of constructive dialogue. They not only got the information to the top, but then they had a serious debate within their management team and others about what this information means. The successful fi rms made wise decisions. The unsuccessful fi rms consistently did not.

The commission interviewed Richard Syron, the former chief executive offi cer (CEO) of Freddie Mac (the Federal Home Loan Mortgage Corporation), one of the largest mortgage companies in the US. In 2005, he had fi red the organisation’s chief risk offi cer. We asked him why, and he said, “The risk offi cer wasn’t sympathetic to our company’s mission.”

At Fannie Mae, the other large mortgage company in the US, we also interviewed its former CEO, Daniel Mudd. His risk offi cer was told at a board meeting in 2006 the company was going to take on a lot of risk. After the meeting, he came back to his offi ce to fi nd an email saying his budget and staff numbers were being cut. This risk offi cer fi red off an email to the CEO saying he could not believe it; that the CEO was increasing the company’s risk and at the same time cutting his capacity to monitor the risk.

Navigatingthe Global Financial Crisis

Jul-Aug 2013 21

rating, to structured mortgage securities that later collapsed precipitously in the crisis. For about ten years, while asset values were going up, the worst securities could get an AAA credit rating but nobody was taking losses from them. From the perspective of the American homeowner, over time the lenders kept lowering their credit standards.

The problem in the global financial crisis during 2007-08 was that there had been a bubble forming but everything looked great. The rating agencies had been reasonably accurate at rating corporate securities but found themselves in a whole new world with extremely complex mortgage securities. The banks were dividing the securities into pieces, or tranches, and the lower-quality parts of the security would be put with another structured security, and the agencies would rate them as AAA as well. The rating of these securities was a mess.

The problem was compounded when more and more mortgages, commercial loans, and other assets went into restructured securities so pricing in the market became totally distorted. Suddenly, after the housing prices peaked and started to go down, people started to take losses on the so-called AAA securities.

These securities are known as “toxic assets” because they were securities that people expected to be safe and suddenly found were not safe. The lenders did not know how big the holes they had in their balance sheets from these toxic assets.

When a highly-leveraged organisation is suddenly taking losses the depth of which they do not know, panic is the inevitable result. This stage of the crisis almost struck down the entire global financial system. The heads of banks were saying to each other, “If I don’t know what’s on my balance sheet, for sure I don’t know what’s on your balance sheet, and I’m not going to lend you money.”

Of course, the financial markets are all interconnected so when everybody pulls back, suddenly there is a “liquidity crisis”, where firms that used to be able to borrow money easily with little warning could not borrow money at all. That is when the US government intervened by flooding the market with guarantees and money. If a firm could not borrow from anybody else, they could always borrow from the central bank and they could stay afloat during

A review of Fannie Mae’s public documents reveals they were saying that they were going to take more risk and they were going to manage it. The problem with risk management is that it can become a gesture rather than a reality. You can say, “we have risk management, and we have a risk officer”. But, in fact, the risk officer may not be having serious input into the decisions that the company is making.

The Genesis of the Financial CrisisFrom the late 1990s, we had a period of what they call the “great moderation”. Everybody was extremely pleased with the way the US government and Federal Reserve was able to manage the economy. Asset values were going up and, in particular, home values were going up.

By about May 2006, housing prices had more than doubled since the mid-1990s. This meant that nobody could make a mistake. They can have the worst decision-making in the world, the least capable people as managers, flawed systems and flawed processes, but everybody looks like they are a hero because they are making huge amounts of money.

Meanwhile the US was having trouble with its rating agencies. They granted AAA, the highest credit quality

22 Global EYE

this disastrous time.

In the middle of a panic, you do not know which banks are merely having a liquidity crisis and which banks are insolvent. The US government ended up lending to just about everybody except Lehman Brothers and a couple of others.

The Banks That SurvivedWhat happened at the well-managed firms? This author found four examples of well-managed firms among the dozen that were looked at. They were JPMorgan Chase, Goldman Sachs, Wells Fargo, and Toronto Dominion Bank.

Housing prices peaked around May 2006, and by October that year, JPMorgan has detected they were having higher mortgage delinquencies than they expected. This is a firm that had superb information systems integrated into their far-flung organisation. The information went up the management chain to the firm’s 15-member operating committee. A Fortune magazine article once described that operating committee when they met as “looking like an Italian family dinner”. What the report meant was that people were arguing and talking over each other, and that is a typical response when you get an early warning flag.

At this time, JPMorgan’s operating committee sought more information to help them make a decision. They found that other firms were having higher delinquencies than theirs on average. So they had a huge argument asking, “What is going on here, what does this mean, how can this happen?” Then they sent instructions down to their investment banking division to immediately shed their exposure to the subprime, low-quality mortgages and securities.

At Goldman Sachs, the firm had taken serious losses in 1994 in their London office. They were a partnership at that time rather than publicly owned, so the partners risked their own wealth if the business took losses.

After they took the unexpected losses in 1994, it had so scarred the firm’s corporate culture that they built a system of controllers parallel to all their trading. As they like to put it, “We’re in the moving business, not the storage business. We don’t want to keep assets on our books. We're constantly trading.”

If a controller has a disagreement with a trader, the higher up the hierarchy the dispute went, the more likely it was for the trader’s opinion to be overturned. Goldman Sachs created a career path where you could be a trader and then a controller, and then a trader. The controllers did not earn quite as much as the traders, but they made a respectable salary and were exceedingly respected within the firm.

In December 2006, during a period of about ten days, Goldman Sachs took losses when their business model said they should have been profiting. Immediately, the head of the mortgage desk sent word up the line to the top of the company. Then, he said, suddenly he was being visited by people at the top of the company looking over his shoulder; people who had never paid attention to mortgages before.

So, like JPMorgan, Goldman Sachs was also gathering information. Then, the top managers at Goldman Sachs had a series of meetings. They decided to get out of the mortgage securitisation business. For Goldman Sachs, it did not mean they had to shed from their portfolio but instead they would hedge. So where they had a long position in mortgages, they would hedge by buying a short position to offset it, so if they took losses on the mortgages, they would gain on the offsetting hedge.

So Goldman Sachs had an early-warning system. But in one area they failed miserably, and that is in what we call reputational risk. When Goldman Sachs was called in front of the US Senate’s Permanent Subcommittee on Investigations, emails were revealed of traders making all sorts of snide comments about the customers with whom they were doing business and how unintelligent they were, and so forth.

Goldman Sachs’ chief risk officer was asked, “You did a really good job with the financial risk but what about your reputation risk?” He said, “Oh, everybody’s responsible for reputational risk.” But, of course, if everybody is responsible, then nobody is responsible. Goldman Sachs learned a very expensive lesson and now they have restructured their control of reputational risk to centralise it.

In 2010, Toronto Dominion Bank’s CEO, Edmund Clark, gave an interview. He said, before the crisis hit, it was

Jul-Aug 2013 23

is you have to listen and understand what is being said and discuss how that fits into your overall strategy.

How Can the Banks be Regulated?From the perspective of bank supervision, regulating a culture is just about impossible. From the perspective of a regulator, a bubble is an almost impossible context in which to regulate effectively. Everything is going well and financial institutions are making money hand-over-fist. If you are a regulator, who is earning a small percentage of a bank CEO’s salary, are you are going to go into the CEO’s office and say, “you’re taking too many risks, you’ve got to stop”?

The question that a financial institution’s CEO and the regulators should be asking of a highly profitable division or office is: “You are in a highly competitive environment; are you making all of this money because you are smarter than everybody else, or because you are taking risks that the rest do not want to take?” Asking that question can be like turning over a rock; you could discover all sorts of things.

There are stories of bank senior managers and risk officers browbeating federal regulators. In a certain meeting, a relatively junior banking regulator was invited to meet with a bank where they started yelling at him, and telling him he was wrong and stupid. It is very hard for a regulator to withstand that kind of pressure, particularly given the political influence that the financial sector has maintained.

What we need now are statesmen in the financial institutions. In the early 1900s, we had a progressive era in the US where leading companies called to reform business practices and created all sorts of oversight structures in government that changed the culture of American business. There is a strong need for a similar approach in the financial sector today, where the firms need to look at how risks are managed, how the regulatory environment is being shaped, and help to improve the way low-quality financial institutions are being run so they can support themselves.

PROFESSOR THOMAS STANTONFellowCenter for Advanced Governmental Studies, Johns Hopkins University

really rough because the stock analysts wrote that he was an idiot. But he looked at this market and said, “I don’t understand how you make money in this market.” (Before heading the Toronto Dominion Bank, Clark had gained a doctorate in economics from Harvard.) He said that he had people coming to his office every week to brief him on sub-prime mortgages. By the time the talks were completed, he said, “I could make a little bit of money constantly, or I could lose everything at once. We’re out.”

The Banks That FailedWhen we interviewed Dick Fuld, the former head of Lehman Brothers, he was asked: “Why did you sideline your risk officer in 2007?” He said, “Nobody could work for her. She was too theoretical.” He then started talking generally about risk, and he used all the right words. He knew enough to be dangerous.

Then we interviewed the risk officer that Fuld had sidelined. He did not fire her; instead, she had been moved into a meaningless job within the company. In her interview, we found her knowledge of risk management was superb. However, it was extremely hard in these badly managed firms to bring any bad news to the top. They were desperately going after market share, revenues and profits.

There was also a problem of organisational complexity. A large complex financial institution may have 1,000 subsidiaries. Citigroup, on the eve of the crisis, had 2,500 subsidiaries. As Charles Prince, the former CEO of Citigroup, joked before the crisis, “Citigroup didn’t have one good culture. It had five or six good cultures.” JPMorgan Chase put all its information systems onto one platform. In contrast, Citigroup kept most of their acquired systems. So on the eve of the crisis, one part of Citigroup was saying the mortgage market was getting very dangerous and the bank should shed its risks. And there were other parts of Citigroup that said pricing of the securities is getting quite good and we could have bought more. So they plunged in more, and the separate divisions never talked to each other.

The second problem is that we are dealing with an amorphous concept like culture. Do you have a culture that allows people at the bottom to report up the line? Are the people at the top listening? You do not need to believe the people reporting down the line, but the point

24

Jul-Aug 2013 25

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THOMAS STANTONFellowCenter for Advanced Governmental Studies Johns Hopkins University

27

Thanks to massive new mining projects coming into production, such

as the Oyu Tolgoi and Tavan Tolgoi mines, Mongolia has had one of the fastest-growing economies in the world over the past fi ve years. From small beginnings, the country’s banking sector has also been developing rapidly. However, it could soon be facing headwinds and signifi cant challenges as the country’s central bank has begun slashing interest rates. These conditions could also curb their immediate ambitions to list on foreign exchanges.

At meetings held in early April 2013, the Monetary Policy Committee (MPC) of Mongolia’s central bank,

the Bank of Mongolia (BOM), decided to cut the country’s interest rates by 100 basis points to 11.5%. The purpose of the cut was threefold: to increase domestic credits and investments; support the country’s real estate sector; and stimulate business activity.

While there were expectations that the Mongolian Government’s budget would have a low impact on infl ation, a decline in demand- and supply-driven infl ationary pressures in the domestic market, and with annual infl ation forecasts for upcoming months being consistent with previously targeted levels, these had the combined effect of enabling the central bank to reduce interest rates.

Mongolia’s Banks are Growing Up

Graph: Mongolia’s Infl ation Target and Projection

20% %

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02011 I 2011 II 2011 III 2011 IV 2012 I 2012 II 2012 III 2012 IV 2013 I 2013 II 2013 III 2013 IV

20

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Source: Bank of Mongolia

Infl ation target:(end - 2013): 8%(2014 - 2015): 6%

Jul-Aug 2013 27Regional BANKING

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The MPC, when making its decision, had obviously kept an eye on the prolonged uncertainties concerning the global investment environment and foreign trade. Foreign investors’ appetite for investing in Mongolia had taken a beating since the global financial meltdown of the late 2000s.

Now that the BOM has been taking measures to stimulate economy, some have concerns over the health of Mongolia’s financial system and Mongolia’s major banks. This article will seek to answer the following questions: What are the policies taken by the BOM to achieve “sustainable growth” in the Mongolian economy? Are Mongolian banks indeed healthy? How likely is it for them to fulfill their ambitions of listing in foreign stock exchanges in the near term?

The Structure of the Financial Sector in MongoliaThe Mongolian financial sector consists of 14 commercial banks, 188 non-bank financial institutions (NBFI), and about 207 savings and credit cooperatives (SCCs). The sector has grown remarkably quickly since it was privatised by the government in the 1990s following the collapse of the Soviet Union in 1991. Up until that point, at least one-third of Mongolia’s economic production was dependent on trade with and aid from the Soviets. Today, the banking industry is highly concentrated, with four banks dominating Mongolia’s retail and commercial banking space. They are:

• XacBank, a community development bank and microfinance institution headquartered in Mongolia’s capital, Ulan Bator.

• Khan Bank, which has its central office and five branches in Ulan Bator. It also has 24 regional branch offices throughout the country, each of which supervises an additional 15 to 25 smaller branches in its area, totaling 512.

• Golomt Bank, which started in 1995 and now manages around 23% of the assets in the domestic banking system.

• Trade and Development Bank, which was formed in 1990 and is therefore the oldest bank in Mongolia. It has a network of 28 branches and settlement centers, 60 ATMs, 1300 POS terminals, and internet banking throughout the country.

The banking industry, which dominates Mongolia’s financial sector, underwent several crises in the 1990s

due to the fallout stemming from the Asian Financial Crisis. Following these crises, the Government implemented measures to restructure banks and improve the Bank of Mongolia’s ability to enforce compliance with prudential regulations, and strengthen market discipline and incentives for sound bank management.

The Mongolian Banking Sector’s Enviroment

• In the third quarter of 2012, non-performing loans (NPLs) as percentage of total outstanding loans declined to around 3%, significantly reduced from the previous year despite the slowdown in the economy’s growth.

• General levels of NPLs were consistently low throughout 2012.

• Real interest rates are going up due to less inflationary pressures.

• Business activities have decreased in 2012. Therefore, coping with the potential fundamental weaknesses of the banking sector in Mongolia could be a top priority for the officials in charge.

• The Deposit Guarantee Law ended in December 2012 after four years of operation. The law provided a blanket guarantee for savings deposits that were issued by the Mongolian Government. This law was replaced by the Deposit Insurance Law, which established a mandatory insurance scheme for the protection of banknotes. Hence, consolidation in the industry is almost inevitable.

Authorities Responsible for Financial Stability The Bank of Mongolia, Financial Stability Council and Financial Regulatory Commission are responsible for the stability and supervision of Mongolia’s financial sector. The BOM is responsible for supervision of banks while the Financial Regulatory Commission supervises other financial institutions, including insurance companies, securities firms, credit and savings unions and non-banking financial institutions. The mission

28 Regional BANKING

29

of the Financial Stability Council is to contribute to sustainable economic growth by developing a sound and competitive financial infrastructure and improving financial services in terms of quality and access.

Strategy for Banking SupervisionThe objective of the Supervision Department is to reduce financial risk and to increase the risk tolerance of the industry. Within this framework, a new banking law was adopted in 2011 by the Mongolian Parliament. The Supervision Department has completed preparatory work for establishing arrangements of consolidated supervision, information technology inspection, proper management monitoring and amendments on supervisory regulations.

As Naidansuren Zoljargal, the governor of the Bank of Mongolia, has pointed out several times in recent years (most recently in an interview with Bloomberg TV in April this year), the role of BOM is to maintain “sustainable growth” in the Mongolian economy. In October 2012, while the governor was making a presentation to potential investors in Hong Kong, he stated that the Mongolian economy should be growing at 16.8% in 2013. However, because of the weaker foreign direct investment (FDI) this year and production delays with the Oyu Tolgoi and Tavan Tolgoi mines, this high growth

rate may not be achievable. On the other hand, inflation peaked at 17% approximately 12 months ago and has been down to single-digit figures recently, which coincides with the target set by the central bank. Going forward, we expect BOM and MOF will implement more coordinated macro policies that focus on stimulating the economy by using both fiscal and monetary policies.

Performance of the Major BanksAccording to the audited financial statements of Mongolia’s major banks, which were released at the end of March, financially the major banks are performing well.

For the Trade and Development Bank, interest income, operating income and net income rose by 48%, 39% and 50% respectively in 2012. Its growth in these indicators was the best among the major banks. However, it is not clear how much of this has come from organic growth. The XacBank’s performance was also reasonably good. Interest income and profit before tax were up 38% and 25% respectively. Profit before tax for the full year 2012 was 20 billion Tughrik (HK$108 million), which is about 25% more than earned in the previous fiscal year. However, the bank’s recent quarterly financial statements reveal the trend of the earnings is declining. The profits before tax for first to

Jul-Aug 2013 29

30

the fourth quarters of 2012 were 4.9 billion, 6.6 billion, 4.8 billion and 3.9 billion Tughrik respectively. Clearly, the momentum for profit growth has been diminishing. While the bank’s financial health is not in question, funding conditions for the bank might be a challenge in the near future.

Challenges for the Banking SectorNorihiko Kato, the chief executive of Khan Bank, recently observed that Mongolia’s banking sector is under pressure and facing some considerable challenges, which they are currently making efforts to address. Uppermost is that while the banks in recent years have become bigger, the quality of their earning has suffered.

Will the IPOs of Mongolian Banks Happen Soon?All major banks in Mongolia have been pursuing opportunities to be listed on foreign stock exchanges in the last few years but none has achieved this

landmark to date. Now, most of major banks’ financial performances are at record highs and they are still growing. So it would appear likely they will each seek a listing on foreign bourses in the near future. Running against this trend is that the quality of their earnings is deteriorating and the momentum for growth is shrinking.

The growth story which has attracted foreign investors in the past is not as compelling as before. Therefore, it is not easy to achieve high valuations on foreign exchanges. As of 13 April 2013, the average price-to-earnings ration (PER) of global banks was around 10 times and the price-to-book ratio was 1.2. Asia ex-Japan's valuation is a bit higher with PER at 12 times and price-to-book ratio of 1.5 times because of the growth potential. Given the slower growth rate of the Mongolian economy and potential problems, we believe the highest valuation they can achieve will be in the range of PER of 15-18 times and price to book of two times. These levels of valuation are unlikely to sit comfortably with the Mongolian banks. Probably they should wait until better days come before listing.

However, there is some light already on the horizon: the recent decision to purchase 16% of Tenger Financial Group, the parent company of XacBank, by Orix Corporation, the Japanese giant conglomerate, was encouraging news to the industry. It may well pave the way for this bank and others to list outside of Mongolia in the near future.

MASA IGATAChief Executive OfficerFrontier LLC

The Mongolian Banking Sector’s Challenges

• Small size of bank’s capital reserves are limiting the banks’ capacity to grow.

• Capital markets and interbank markets remain underdeveloped compared to neighbouring economies.

• Lack of long-term funding sources has resulted in a gap in the banks’ maturity.

• Underdeveloped derivative markets and hedging instruments.

• Legal and regulatory framework needs further reform, for example, the movable assets pledge, non-banking financial services, and so on.

• Underdeveloped risk management and system investment.

• Compliance with international anti-money laundering and know-your-customer rules still need development.

30 Regional BANKING

31Jul-Aug 2013 31

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• Small size of bank’s capital reserves are limiting the banks’ capacity to grow.

• Capital markets and interbank markets remain underdeveloped compared to neighbouring economies.

• Lack of long-term funding sources has resulted in a gap in the banks’ maturity.

• Underdeveloped derivative markets and hedging instruments

• Legal and regulatory framework needs further reform, for example, the movable assets pledge, non-banking fi nancial services, and so on.

• Underdeveloped risk management and system investment

• Compliance with international anti-money laundering and know-your-customer rules still need development.

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02011 I 2011 II 2011 III 2011 IV 2012 I 2012 II 2012 III 2012 IV 2013 I 2013 II 2013 III 2013 IV

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MASA IGATA

Frontier LLC

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What effect do laws have on the wealth management industry in emerging

markets? How do changes in laws affect the wealth of whom are known as high net worth and ultra-high net worth individuals?

For banks and wealth management fi rms that want to indentify and increase the number of client prospects in emerging markets and advise them on how to expand their wealth, these are important questions. Recent research suggests the best way that banks in Hong Kong, Singapore and other jurisdictions can expand into developing markets may be to lobby to improve the quality of laws in countries such as Indonesia, Malaysia and Brazil.

When thinking about the connection between laws and wealth management, it is worthwhile to study the island of Labuan. Labuan is an offshore fi nancial centre created by Malaysia in 1998 by the Labuan Offshore Securities Industry Act. The point of the exercise was to create an offshore banking centre where they could attract investment funds from other countries, such as

China, which would be used to fund its development.

However, we have seen that the intention has not materialised into reality. The Act did not generate as much capital as they had been looking to raise. It did not create any millionaires. So we have to ask ourselves, “why is that?” They passed this Act so that essentially you need very few registrations to operate in Labuan, low taxes, little banking supervision and minimal securities supervision. Yet it has not developed into an international fi nancial centre that would rival others such as Hong Kong, Singapore, and Bermuda; nor has it been able to attract similar amounts of capital as those cities.

So what went wrong, and what is the rule of fi nancial law in this process? This article will expand on this question by addressing the following three questions: How does the law affect the way these large private banks and wealth-management fi rms fi nd wealthy clients? How does that affect the way that they make them wealthy? How does the law affect the way private banks and wealth-management fi rms help client

Creating Wealth in Emerging Markets

Financial REGULATION

Jul-Aug 2013 35

relationship managers give these millionaires and billionaires what they really want?

Creating WealthBefore we discuss these questions, let us look at wealth creation. Where is the world’s wealth located now and what role have laws played in the generation of this wealth? Of course, the United States is the most wealthy jurisdiction. However, we have also seen wealth grow – and the number of high-net wealth individuals and ultra-high-net wealth individuals grow – very quickly in certain emerging markets, such as Brazil, Russia, India and China.

It is uncertain exactly why this has occurred. It cannot be explained with complete certainty why wealth has changed more in China than, for example, in Indonesia. Nonetheless, there are theories.

The gross domestic product of a country can be expressed as a combination of four factors: capital; labour; land; and knowledge (sometimes referred to as “alpha”). From reviewing the latest economic research,

it is also certain the amounts of investable funds is not explained by changes in equity holdings, stocks, or smarts (alpha) over time.

In the last 15 years, macroeconomists have told us institutions are the main explanatory variable in creating wealth. For instance, Nigeria has better institutions than the Congo, and that is why Nigeria is richer. The US has better institutions than Nigeria and, therefore, the US is richer. However, when looking at this literature we find that does not really explain very much.

What are institutions and how does the law interact with the way that banks and wealth-management firms create wealth? What do we know about emerging markets, and creating wealth in these markets? We know that the asset allocation approach to wealth management (when wealth managers and private bankers advise on when and how much of their clients’ money should be allocated into certain proportions of stocks and bonds and other asset classes) will not generate as much in returns in emerging markets as it does in developed markets.

When comparing different countries, we find wealthy people tend to want different proportions of their assets in certain financial products such as life and health insurance, and legacy management (another way of saying they are leaving their money to their children). The paper, “Does Financial Market Development Explain (or at Least Predict) the Demand for Wealth Management and Private Banking Services in Developing Markets?”, contains data showing that insurance markets in the US and United Kingdom are far more capitalised than markets such as Jordan, South Korea, Taiwan, and so on.

It is hard to believe that Americans simply prefer to have more life insurance than South Koreans. There has to be some other explanation for why we see differences in preferences for certain kinds of assets like insurance, stocks, and estate planning across different jurisdictions.

Wealth-management services make the wealthy far less wealthy in emerging markets than it does in developed

36

markets. We know the rule of law affects wealth more than other factors. According to the regression analysis, if your country has more rules of law, you are going to be far wealthier than anything your wealth manager can do for you.

However, it is not necessarily banking and securities law that determines the profitability of wealth management. It is simply the quality of the laws in general.

We can be certain that investors prefer some jurisdictions over others. We know for a fact that rates of return on equity in different markets do not determine the amount of money that goes into that market. For instance, Turkey has been one of the highest-performing markets over the last several years. Yet they have not been one of the countries that have been attracting the most amounts of investable funds from overseas sources.

What if you were to ask a Saudi Arabian millionaire or billionaire to put their money into the Saudi stock market? Or Malaysia, where there is Islamic banking? They would most likely refuse. Their money is most likely in London and Switzerland.

Are the Swiss able to provide far higher returns than anywhere else in the world? Econometric analysis and common sense tells us it is probably not the rates of return in Switzerland that is driving these capital inflows. It is most likely the security that Swiss law gives investors comfort they will be able to go into a Swiss bank and recoup the funds they placed with their asset managers.

That should tell private bankers not to open an office in Riyadh or Tripoli in order to attract Middle Eastern high-net wealth individuals because they are more likely to get to manage Middle Eastern money in Geneva or London. Similarly, if a banker was interested in attracting wealthy Nigerians, for example, the temptation would be to open an office in Nigeria and vigorously pursue prospects there. However, the econometric research in the paper, previously cited,

reveals it would be a far more effective strategy to establish an office in an established financial centre, such as London, to attract wealthy Nigerians in the short term, and to lobby the Nigerian Government, either through the local bankers’ association or members of Nigeria’s National Assembly, to improve the country’s quality of laws before prospecting for clients there in the long term.

How Better Laws Lead to Wealth CreationIt is the nexus of laws that drive investors to a jurisdiction: contract law, civil law, land law, criminal law and a constellation of other laws and regulations. That nexus of laws is what provides overall security to the investor, which explains the returns in the wealth-management industry far more than simply looking at banking or securities laws.

The next question to ask is that if the UK laws are so great, why don't we just copy it? The answer is it is just not that simple. Best in class law does not make an international financial centre.

Cities such as Casablanca and Dubai have copied laws from other countries and simply eliminated certain parts of banking and securities regulations to make them essentially free ports. You invest your money in whatever you want there with very little supervision and hope for the best. In theory, these jurisdictions should be the places that generate the highest rates of return. Yet we see that in Casablanca, Dubai and other emerging markets that “porto francos” do not generate the kinds of investment returns and wealth that we see in more developed markets like London and Hong Kong, and increasingly in places such as Turkey where the laws are reasonably good.

So how do we explain the fact that Labuan – with its relatively lax banking and securities laws, and laws that have been engineered to attract wealth from other countries – has failed? Not only does Labuan not have Hong Kong’s banking and securities laws, they do not have its civil laws and common law traditions, which help protect the wealth of high-net wealth individuals.

36 Financial REGULATION

37Jul-Aug 2013 37

Furthermore, when you visit Labuan and meet some of the bankers there, you see very clearly the way they think about wealth and the way they relate to their customers is very different to how bankers relate to clients in New York or in Switzerland. They do not have the “YWIMC” mentality: your wish is my command. When a wealth manager is trained in large financial organisations, such as HSBC, the Bank of America or Morgan Stanley, they will tell you that when your client calls you at two in the morning and they want pizza for their son who is in university, you will go get that pizza. You are not just managing their money, you are managing the relationship. What you will find is that managing a relationship requires lots of different branches of law, not just banking law.

Wealth management fits into the international financial centre ecosystem and cannot be separated from other parts of banking or securities. It would be in the interests for wealth managers and banks, particularly in emerging markets, to call for better civil law provisions, criminal law provisions and competition law provisions. It is those kinds of changes which will attract and create wealth, and which will in the long run make these jurisdictions more attractive to the large global financial institutions.

As economists, we know the returns on wealth are fixed to the marginal product of capital. However, laws are also an important component in the equation. For instance, how well a shoemaker makes shoes is dependent not only on the maker’s materials and labour but also on the quality of contract laws: how easily can a contract for materials be struck, how safely can the maker send shoes to customers and be paid, how cheaply can a maker buy insurance for their factories. So while this example illustrates how contract law is a determining factor in the marginal product of capital, it is also dependent on the quality of the whole nexus of laws within a jurisdiction.

Therefore, it would be within the interests of banks and other financial institutions to lobby for laws that raise the marginal product of capital in an emerging market rather than simply seeking to encourage countries to

have laws that keep clients’ account details secret or optimise tax efficiency. Wealth managers in emerging markets that focus on the laws affecting the marginal product of capital will find they will be able to attract and retain more wealthy clients, which is what the wealth managers have done in New York, Switzerland, Germany and London.

Dr Michael’s paper, “Does Financial Market Development Explain (or at Least Predict) the Demand for Wealth Management and Private Banking Services in Developing Markets?”, is available at: web.hku.hk/~bmichael/publications/HNW%20paper4.pdf

DR BRYANE MICHAELSenior FellowUniversity of Hong Kong’s Faculty of Law

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39Jul-Aug 2013 39

BRYANE MICHAEL

40

Itwould be entirely fair to describe Henry Steiner as Hong Kong’s godfather of design. His work can be

seen everywhere and every day: he is the author of some of this region’s most iconic corporate images.

One of these is the logo for HSBC, which he modestly describes as based on Scotland’s Cross of St Andrews fl ag which he “made into a square and then added those extra ‘ears’ to it to hold it together”, he says.

Steiner fi rst arrived in Hong Kong in 1961, and established his practice three years later. One of his most famous commissions can be seen whenever you open your wallet. It was Steiner, in 1973, who fi rst featured the two lion statues in front of the Hongkong and Shanghai Corporation’s headquarters on the currency notes issued by HSBC. He has also been the designer for the notes issued by Standard Chartered Bank (Hong Kong) since 1979.

It is not a simple brief to design a bank note. To start with, how do you make a piece of paper convey value?

One way is for the design to conform with certain security requirements to ensure the note is genuine. This includes using engravings of images featured on the note, patterns that are extremely diffi cult to mimic

accurately, and having a watermark. Another way is that the note’s design communicates its value by showing something about the country’s culture, Steiner says.

“Often there will be a celebrity or an important fi gure, such as a president. Except for banknotes in Third World countries, these people are usually dead. But in the Third World, they like to enjoy [being on a banknote] while they are around,” he jokes.

Up until the early 1970s, Hong Kong banknotes often depicted images of the banks’ headquarters, and also an anonymous woman dressed in ancient Greek or Roman garb and wearing what Steiner jokingly describes as a “fi reman’s helmet”. Some even sported the mythical fi gure of “Britannia”.

Mythical AnimalsWhen Steiner was commissioned to design the 1979 series of notes for the Chartered Bank (as it was then known), he took a radical approach of suggesting they should feature mythical Chinese animals. Ascending in value, the set of banknotes that were issued in this series started with the fi sh on the $10 note, a lion on the $50, a chi-lin (unicorn) on the $100, a phoenix on the $500 and the dragon – the most potent Chinese mythical animal – on the highest denomination, the

The Man Who Designs the Notes

40 Talk Around TOWN

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$1000 note. It was the first time in Hong Kong that an international bank had used Chinese iconography prominently.

“I thought the mythical animals have a certain charm and are in tune with Chinese tradition,” Steiner says. “Half by accident, they fall into a hierarchy according to their denomination ... There is a myth about the fish that goes over the cataracts until it reaches the dragon gate, which is a narrow passage. If it gets to that point and goes through it, the fish turns into a dragon. So there is a circularity to the story.”

The designs proved highly popular, and they still feature on Standard Chartered Bank’s current series, also designed by Steiner. And when the Hong Kong Monetary Authority (HKMA) decided in the mid-1980s the three banks should add a $20 denomination to their notes, Steiner added a tortoise to the set; inspired by a large bronze sculpture of a tortoise he saw in Beijing’s Forbidden City. However, when the HKMA chose to issue its own $10 note exclusively from 2002, the lion design was sacrificed and the fish was moved to the $20 note and the tortoise to the $50 denomination.

A Study in ContrastsNew designs are usually commissioned every seven years because it is estimated this is how long it takes for skillful forgers to begin making accurate copies of banknotes. Steiner has taken the opportunity each time to refine the look of the mythical animals, and also make significant changes to the reverse side of the notes.

In the latest series of Standard Chartered Bank notes, released in 2010, Steiner’s design for the reverse side of the notes evoked the contrasting themes of Hong Kong’s heritage and technology. This was quite a departure from the previous series, in 2003, which featured depictions of Hong Kong’s famous landmarks at various points in its history. The 2010 series has on the $1000 note a Tang dynasty coin shadowed by a modern smart chip, the $500 note features a traditional face reading chart and a biometric recognition system, the $100 has a seal with Sung dynasty characters

superimposed over a circuit board, while the $50 note has an ancient Chinese lock and a modern bank vault door and the $20 has an abacus against a binary code pattern.

The deliberate contrasts in these designs harks back to one of the lessons Steiner learned from his teacher at Yale, Paul Rand, one of the giants of the design industry in the twentieth century.

“He said, ‘Every design to give it life has contrast.’ It can be psychological contrast, where you see two things that do not go together. Or it can be visual contrast. If you had a piece of wallpaper with a polka-dot pattern, that is not graphic design, it is just decoration. But if you change something in there so you see it in a different way, that gives it a visual contrast,” Steiner says.

A Special RequestWhile preparing for the 2010 series of notes, Steiner was given a special commission to design a $150 note to commemorate Standard Chartered Bank’s 150th anniversary. He was given a daunting deadline of just six months and a brief from the client that every designer should dread: “When I asked, ‘What do you want on the note?’ He said, ‘You’re the designer, Henry’,” Steiner says.

After some initial ideas were rejected, he visited a local art gallery where he saw a photograph of a crowd on a Hong Kong street. It and another picture of a group of people reminded him of a classic print by Japanese artist Katsushika Hokusai showing a group standing on a bridge and looking at Mount Fuji in the distance.

Jul-Aug 2013 41

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It was the inspiration that gave him the idea to portray people representative of Hong Kong’s history over the past 150 years looking from the Peak over Victoria Harbour.

The idea met with approval, and in the final version, the people in the scene include a colonial era-policeman, a contemporary schoolboy, a traditional mother and child, a modern businessman, a bird fancier, a young housewife and a Chinese coolie. The front cover shows a satellite image of Victoria Harbour and the bank’s headquarters.

“To do that in a six-month frame was tight,” he says. “It included taking photographs with a photographer who was willing to during Chinese New Year and to get all those people in the right costumes.”

One million notes of the commemorative issue were printed and they were first released for sale in 2009. It remains the only $150 note ever issued in the world. While the issue was aimed principally for collectors, some of the notes have been used in general circulation.

“Some people spent it, which is ridiculous because you had to pay just under $300 to get one,” Steiner says.

Hong Kong’s Design IndustryWhen speaking about the design industry in Hong Kong, Steiner conveys strongly-held opinions. He believes the industry has not evolved in the way he hoped it would when he first moved to Hong Kong in 1961, particularly in the field of graphic design. But he does not blame the designers.

“I am disappointed at the progress that design has made. I lay that at the feet of the clients rather than the designers,” he says. “The clients are more concerned with price than quality. They feel if you can get a logo for $10,000, why pay more? They do not see the difference [because] they have had no education [in the arts]. There are art departments at some of the universities, but leading up to that, there is no general sense of music and art to give you a platform of appreciation.”

Steiner also has reservations about initiatives such as the Hong Kong government’s plans for a cultural district in West Kowloon (“It should be closer to the middle of town rather than in boondocks,” he says). However,

he sees pockets of design excellence in Hong Kong, particularly in the designing of products, such as the cookware inspired by traditional Chinese cooking equipment that was created by the firm Office for Product Design.

Steiner says he impressed most of all with the students and young people who could become the next generation of designers coming through in this region.

“The ones who are coming into their own now are independent, civil and broad-minded. They are terrific,” Steiner says. “They are very keen on universal suffrage. I’ve asked, ‘Where does this come from? They haven’t picked it up in the schools.’ The answer is: the internet. They are going to be counter-culture in a way, and I am very pleased with that.”

BRUCE ANDREWSGeneral Editor

42 Talk Around TOWN

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石漢瑞 談鈔票設計

Jul-Aug 2013 43

4444 淺酌談

45Jul-Aug 2013 45

46 HKIB News

A Warm Welcome to New Vice Presidents and Executive Committee Members

Mr Shou Fugang Mr Felton Lau

Mr Raymond Cheng Ms Candy Leung

The Institute warmly welcomes the joining of Mr Felton Lau and Mr Shou Fugang as Vice Presidents of the HKIB Council; and Mr Raymond Cheng and Ms Candy Leung as members of the HKIB Executive Committee.

Mr Felton Lau is an Executive Director of Chong Hing Bank and has been appointed its Chief Executive Officer since 7 March 2013. Mr Lau joined the Bank as its Chief Auditor in 1988 and became a Director of the Bank in August 2001. He was a Deputy Chief Executive Officer of the Bank from 11 July 2007 to 6 March 2013. Before joining the Bank, he had worked for an international bank and an international accounting firm.

Mr Shou Fugang is the Chief Executive (CE) of Bank of Communications Co., Ltd, Hong Kong Branch. Before his appointment as CE, Mr Shou was the Deputy General Manager of the Hong Kong Branch, responsible for supervision of treasury activities, fund management and information technology. Mr Shou joined the bank in 1987. He worked for Bank of Communications, New York Branch, between August 1991 and October 1993. Before his assignment in Hong Kong, Mr Shou was the Deputy General Manager and Treasurer of the bank’s International Banking Department, Head Office.

Mr Raymond Cheng is Deputy Chief Executive of Bank of Communications Co., Ltd. Hong Kong Branch, responsible for the bank’s overall risk management function. Mr Cheng has over 24 years’ experience in the banking industry. Before this role, Mr Cheng was Deputy

General Manager of Bank of Communications Co., Ltd. Macau Branch.

Ms Candy Leung is Head of Talent Development of Standard Chartered Bank (Hong Kong) Limited. Ms Leung has close to 20 years of experience in banking and financial institutions working in consumer banking, commercial banking and human resource functions. Ms Leung joined Standard Chartered Bank in 2004 and she has held various roles in Learning & Talent Development function.

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One of the most important events of HKIB, the Council Luncheon not only sums up achievements but also presents forward-looking initiatives. This year’s Council Luncheon was held on 11 June 2013 at HSBC. The event was hosted by Mr Peter Wong, Chief Executive Asia Pacific of HSBC and President of HKIB and attended by 12 Council and 13 Executive Committee (EC) Members including Mr Ashley Alder, Chief Executive Officer of the Securities and Futures Commission and Vice President of HKIB and Dr Patrick Fung, Chairman and Chief Executive of Wing Hang Bank cum EC Chairman; along with the Secretariat.

Mr Wong warmly welcomed all the guests and gave special thanks to Council and EC members for their guidance and support rendered to HKIB. Dr Fung and Ms Carrie Leung, CEO of HKIB also spoke on the occasion. In presenting the Institute’s accomplishments, Dr Fung highlighted the accreditation of HKIB’s programmes under the Qualifications Framework (QF), a milestone achievement taking HKIB on its visionary course to become a “certifying” and “training” centre of the industry. The accreditation makes HKIB the first and only non-academic local institute offering a QF Level 6 programme. Dr Fung stressed that the accredited programmes can serve as a comprehensive set of competency standards to help

Council Luncheon Shares Edges of Programme Accreditationpractitioners meet the requirements for technical and ethical competence stated in the Supervisory Policy Manual, supporting talent development and banks’ compliance. Importantly, the qualifications’ increased transferability is expected to help banks reduce training costs while the specified development paths can further promote bankers’ excellence. In looking back at the Institute’s proud history, it has grown from a 158-member organisation to today’s one of the most representative professional organisations whose programmes and services are directly accessible by 90% of the banking practitioners in Hong Kong.

In her speech, Ms Leung hoped that Council Banks would give their full support for HKIB’s trainings through administrative means and encouraging their staff to become HKIB members. She specially thanked the EC, Membership and Professional Development Committee and Professional Standard and Examination Board for their support and guidance during the accreditation process. 2013 marks the 50th anniversary of the Institute. Ms Leung thus extended a cordial invitation to all the guests present as well as their staff to the 50th Anniversary Gala Dinner, which will be held on 7 October 2013.

With the continuous development of the banking industry, HKIB is at the most dynamic stage of its development and growth.

Members of Council, Executive Committee and Secretariat at the Annual Council Luncheon. (From left, front row) (7th) President, Mr Peter Wong, Chief Executive Asia Pacific of HSBC; (6th) Vice President, Mr Ashley Alder, Chief Executive Officer of Securities and Futures Commission; (8th) Chairman of Executive Committee, Dr Patrick Fung, Chairman and Chief Executive of Wing Hang Bank, Limited.

Council Members at the HKIB Annual Council Luncheon. (From Right) Mr Peter Wong, President of HKIB; Mr Adrian Li, Mr Weber Lo and Mr Zhu Qi, Vice Presidents of HKIB.

48 HKIB News

Elite Seminar Enlightens on Mainland Developments and New Opportunities

Mr Shang Fulin, Chairman of the CBRC, took photos with the participants at the graduation ceremony.

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高層研修班：瞭解國情，掌握機遇

First CPD Public Training Programme in Macau

50 HKIB News

The Institute’s Executive Committee has elected the following members to Certified Professional in Credit Management (CPiCM), Certified Financial Management Planners (CFMP) and Accredited Banking Practitioners (ABP). All members have completed the CPiCM, CFMP and ABP Examinations respectively. They have also fulfilled the membership and working experience requirements as prescribed by the Institute. They are now entitled to use the designation “CPiCM”, “CFMP” and “ABP” respectively with up-to-date membership.

Welcome Our New CPiCM, CFMPs and ABPs

☐ CPiCM

Tam Man Sang

☐ CFMP

Chan Chan Wai Ieong Kam Peng Mok Man Pio

Chan Chon Im Ip Chi Ian Ng Ka Ka

Chao Hou In Iun Meng Hou Ng Ka Wai

Che Kim Pan Kam Ut Ian Ng Teng Fong

Cheang Kim Ieng Kou Kam Sim Ngan Hio Peng

Chen Qiu Shi Kuan Wa Lam Ngan Iek Hang

Cheong Si Lei Lam Mui Iok Sam Teng Ut

Chio Hou Fai Lao Chi Hou Si Pek Fong

Chio Mei Fong Lau Ut Meng Sou Ka Kit

Choi Mei Leng Law Wai Kwan Vong Chi Kuong

Choi Sut Kan Lei Man U Vong Kan Hoc Jacinta

Chong Kiu Chik John Lei Un Mei Wang Mila

Chong Mei Peng Lei Weng Kao Wong Lai In

Chu Chong Cheong Lei Weng Lok Wong Mei Leng

Chu Lai Seong Leong Man I Wong Oi Sio

Ho Chi Hou Lin Xiuling Wong Wing Lam Kate

Ho Kuan Leng Lo Pou Chan Zhang Jing

Iao Sut Fan Mak Choi Fong

☐ ABP

Au Yeung Ka Ling Pun King Hei Wong Chung Man

Kwok Wing Sheung Wan Ka Wing Wong Yuen Ying

Ng Chung Yin Tracy

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Opportunities for Learning are Endless...

More Professional Training Coming in July - Aug 2013

Course Remarks Programmes Dates Duration Fees HKIB CEF (Hours) (Members) CPT

☐ Professional Training Programmes

The Foreign Exchange Regime for PRC Cross-Border RMB / Foreign Currency Financing

12, 19 & 26 Jul (Fri) 9 Hours $1,350 √ –

16 Jul (Tue) 3 Hours $600 √ –

Workshop on Regulatory Overview of RMB Clearing and Trade Account Services Outside the PRC

19 Jul (Fri) 3 Hours $900 √ –

Using Company Shares/Insurance Policies as a Form of Security in Bank Financing 20 Jul (Sat) 3 Hours $1,050 √ –

Key Credit Risk Management Principles – Collateral and Guarantee 20 Jul (Sat) 3 Hours $1,050 √ –

Ethics and Corporate Governance 24 Jul (Wed) 3 Hours $600 √ –

27 Jul (Sat) 4 Hours $700 √ –

Regulatory Driven Evolution of Risk Management Practices in Banking Industry – Past, Present and future

30 Jul (Tue) 3 Hours $600 √ –

Introduction to Fixed Income Securities 7 & 14 Aug (Wed) 6 Hours $1,200 √ –

Annual Update on Anti-Money Laundering Workshop 8 Aug (Thu) 3 Hours $900 √ –

Regulatory Requirements Relating to Structured Products – Wealth Management 9 Aug (Fri) 3 Hours $1,050 √ –

Key Credit Risk Management Principles – Large Exposure and Risk Concentration 10 Aug (Sat) 3 Hours $1,050 √ –

Account Opening Documentation Requirements from Legal and Regulatory Perspectives

10 Aug (Sat) 3 Hours $900 √ –

Essential Risk Management for Financial Service Executives 21 Aug (Wed) 3 Hours $600 √ –

*HKIB reserves the final right to cancel, modify and/or postpone the course.

Enquiry Hotline: 2153 7877/ 2153 7865 Fax: 2544 9946 Email: programme@hkib.org Website: www.hkib.org

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