Elements of Business

Topic 7

HONG KONG AS A
FINANCIAL CENTRE
 Intended Learning Outcomes
2

1. Define the meaning of money.

2. Outline an overview of the monetary

system and financial sector in Hong Kong.

3. Explain the money supply process of Hong

Kong and the Linked Exchange Rate
System.

2
Tequila Crisis
On Dec. 20, 1994, the Mexican peso was devalued. The Mexican economy had improved greatly since 1982 when it last
experienced upheaval, and interest rates on Mexican securities were at positive levels.
 Economic reforms from the late 1980s
 The assassination of a Mexican presidential candidate in March of 1994 sparked fears of a currency sell-off.
 The Mexican central bank was sitting on an estimated $28 billion in foreign reserves. In less than a year, the reserves
were gone.
 The central bank began converting short-term debt, denominated in pesos, into dollar-denominated bonds. The conversion
resulted in a decrease in foreign reserves and an increase in debt.
A self-fulfilling crisis resulted when investors feared a default on debt by the government.
 Why study money and monetary policy?

 Evidence suggests that money plays an important

role in generating business cycles.
 Recessions (unemployment) and expansions
affect all of us.
 Monetary theory ties changes in the money supply
to changes in aggregate economic activity and the
price level.
 Money, Business Cycles, and Inflation

 The aggregate price level is the average price of

goods and services in an economy.
 A continual rise in the price level (inflation) affects
all economic players.
 Data shows a connection between the money
supply and the price level.
 Aggregate Price Level and the Money
Supply in the United States, 1950–2014
6

Source: Federal Reserve Bank of St. Louis, FRED database: http://research.stlouisfed.org/fred2

 Average Inflation Rate Versus Average Rate of
Money Growth, Selected Countries, 2003-2013
7

Source: International Financial Statistics. http://www.imf.org/external/data.htm

9 in 10 HK consumers won’t shop without preferred payment method
About 93% of Hong Kong consumers will not purchase online if their preferred payment
method is unavailable, the highest rate amongst APAC countries surveyed
 What is money?

 Money (or the “money supply”) is anything that

is generally accepted as payment for goods or
services or in the repayment of debts.

 Thus, money in economics has a rather broad

definition. There are many things that can meet
the definition of money such as currency (paper
money and coins), checking account deposits
and saving deposits.
 What is money?

 Functions of money:

1. Medium of exchange

2. Unit of account

3. Store of value
 Evolution of the payments system

1. Commodity money
 Money is made up of precious metals or
another valuable commodity. It was commonly
used in ancient times.
2. Fiat money
 Paper currency decreed by governments as
legal tender (meaning that it must be accepted
as legal payment for debts).
 Evolution of the payments system

3. Checks
 It is an instruction to your bank to transfer
money from your account someone else’s
account when she deposits the check. It is still
an important means of payment for large
denominated transactions or for evidence of
payments.
 Evolution of the payments system

4. Electronic payments
 Debit card: transfer funds from the cardholder’s
account directly to a merchant’s account. In
HK, we call this as EPS.

 Stored-value card: depositing some money into

the card in advance and then making payments
when used. In HK, we have Octopus.
 Evolution of the payments system

4. Electronic payments
 E-money: instead of carrying physical card,
payments can be made to merchants over
internet or mobile phone (apps). In HK, we have
TNG Wallet, Apple pay, Tag & go.

 Note credit cards do not represent money in

economics as it is just a loan provided by banks
to cardholders to make purchases. Cardholders
still owe banks and the transactions are not
completed.
 Hong Kong beats Singapore to be Asia's top financial center
Hong Kong has reclaimed its position as Asia's top financial center, surpassing Singapore.
Globally, Hong Kong is now ranked third, behind New York and London. The latest Global
Financial Centres Index also saw cities like Dublin, Chicago, and Dubai rise in the rankings.
 Hong Kong as Financial Center

 No exchange control (free capital mobility)

 HK dollar linked to the US dollar
 Simple and low tax rate system
 Fast growth in the region
 Good geographical location
 Free flow of information
 Effective legal system
 Common use of English
Hong Kong Linked Exchange Rate System

 Currency Board System

 Pegged HKD to USD at $7.8
 Two Currency Exchange Markets in Hong Kong:
1. Official Market
2. Open Market
 The Currency Board System

 A traditional currency board sets the exchange

rate through convertibility undertaking
 buys/sells FX passively for domestic currency
(DC) at the prescribed exchange rate
 the board does not intervene in the FX market
or take the initiative to buy/sell FX
 The currency board issues new currency only
upon receipt of an equal amount of FX at the
prescribed exchange rate
 so domestic currency fully backed by FX
The Three Refinements
 The Three-tier System

 Licensed banks (LB)

numbering 31 + 131 = 162
 Restricted licence banks (RLB)
numbering 12 + 4 = 16
 Deposit-taking companies (DTC)
numbering 12 + 0 = 12
 Incorporated in HK + Incorporated outside HK =
Total
 Figures as at May 1, 2021, numbers shrinking
 Altogether known as Authorized Institutions (AIs)
 Three-tier Banking System

 LB: can operate current and savings accounts,

accept deposits of any size and maturity, pay or
collect checks drawn by or paid in by customers
 RLB: principally engaged in merchant banking
and capital market activities, may take deposits of
any maturity of HK$500,000
 DTC: mostly owned by or associated with banks,
engage in a range of specialized activities,
including consumer finance and securities
business, may take deposits of HK$100,000 or
above with an original term of maturity of at least
three months
 Why Study Financial Institutions
and Banking?

 Financial intermediaries: institutions like banks

that borrow funds from people who have saved
and in turn make loans to other people. The
process performed by banks of taking in funds
from a depositor and then lending them out to a
borrower is known as financial intermediation.
 Why Study Financial Institutions
and Banking?

 2. Banks are adept at:

i) pooling funds: Banks attract funds from
individuals with small amounts to invest and pool
those savings to buy financial securities that are
available only in large denominations.
ii) gathering information about borrowers: banks
specialize in knowing about small business firms
so that depositors do not have to. This makes
efficient allocation of funds and promotes economic
growth.
Financial system
 Why Study Financial Institutions
and Banking?

 Financial innovation: the development of new financial

products and services.
 With the rapid advances in computer technology,
burdensome financial regulations, the accelerating
financial disintermediation, financial institutions found
that many of the old ways of doing business were no
longer profitable. To survive in the new economic
environment, financial institutions had to research and
develop new products and services that would meet
customer needs and prove profitable, a process referred
to as financial engineering.
Financial Tsunami
After Lehman Brothers declared bankruptcy in September 2008, approximately twenty-six thousand of the firm’s employees
worldwide lost their jobs, and investors suffered immense losses, fueling the country’s greatest economic downturn since
the crash of 1929. On September 16, 2008, one day after Lehman’s collapse, the Federal Reserve Bank of New York lent
$85 billion to the global insurance company American International Group (AIG), whose assets failed to cover its mounting
credit default swap contracts. As confidence in the banks eroded, borrowing rates rose and home foreclosures continued to
spike. Lawrence McDonald, author and a former vice-president at Lehman Brothers, reflects back on the devastating cost
brought about by the collapse, recognizing that “every fraction of every inch of those financial graphs represents hope or
fear, confidence or dread, triumph or ruin, celebration or sorrow.”
 Why Study Financial Institutions
and Banking?

 Financial crises: Sometimes imprudent banks’

lending policy and financial innovations might
cause major disruptions in financial markets that
are characterized by sharp declines in asset prices
and the failures of many financial and nonfinancial
firms. These will cause economic downturns,
chaos as well as bankruptcies of banks.
 Fiscal Policy and Monetary Policy

 Monetary policy is the management of the money

supply and interest rates
 Conducted in the United States by the Federal
Reserve System (Fed)
 Fiscal policy deals with government spending
and taxation
 Budget deficit is the excess of expenditures over
revenues for a particular year
 Budget surplus is the excess of revenues over
expenditures for a particular year
 Any deficit must be financed by borrowing
30
 Financial Sector of
Hong Kong

31
 Financial Sector of Hong Kong

 Hong Kong is one of the most vibrant

international financial centres in the world.

 The financial services sector has been playing an

important role in the local economy.

 Its contribution to the Gross Domestic Product

(GDP) reached to 21% and 22% in 2021 and
2022 respectively.
 Financial Sector of Hong Kong

 The financial services sector consists of:

 banking industry
 insurance industry and

 other financial services industries.

 In 2022, the financial services sector employed

269 700 persons, or 7% of total employment in
Hong Kong.
 Financial Sector of Hong Kong

 Within the financial services sector, the banking

industry has been playing a pivotal role.

 In 2022, it accounted for 36% and 69%

respectively of the total employment and value
added in respect of the entire financial services
sector.