Liberalising Commercial Banking and Upgrading Local Banks

Date: 17 May 1999

1   The Government is introducing measures to liberalise the commercial banking sector and upgrade local banks. The aim is to move towards a more open and competitive environment, so as to spur the development and upgrading of local banks. This will strengthen our banking system, provide Singaporeans with quality banking services, and enhance our position as an international financial centre

2   Strong and well-managed local banks, with a significant share of the payment system and home market deposits, are critical to sound banking systems in all developed countries. Singapore is no exception.

3   Unlike other countries, Singapore's financial sector started with a high level of foreign bank participation. As a colony, the banking scene was dominated by foreign banks, such as the Hongkong and Shanghai Banking Corporation (HSBC) and Standard Chartered Bank. Local banks were small and insignificant. Over time they consolidated into fewer, larger banks, but even in the early 1970s, foreign banks had over two-thirds of total bank deposits.

4   Since the early 1970s, MAS has adopted policies to protect the local banks, especially in retail banking, so that they could grow and assume a larger share of the domestic market. There is a three-tier licensing system for commercial banks, comprising full banks, restricted banks, and offshore banks ¹. No new licences for full and restricted banks have been granted since 1970 and 1983 respectively. Foreign full banks are not allowed to set up new branches or re-locate existing branches; install off-premise ATMs or share ATMs with other banks; or offer Electronic Funds Transfer at Point-of-Sale (EFTPOS) services.

5   However, in wholesale banking, and in treasury and capital market activities, foreign banks compete more freely with local banks, while offshore banking is completely open.

6   Government protection and strict MAS supervision have enabled local banks to grow into sound, well-capitalised institutions. The recent crisis revealed the weak-nesses of many regional banks, but our local banks stood out as among the soundest in Asia.

7   However, while Singapore banks may be large by regional standards, by international standards they are small. They also lag behind the best international banks in terms of technology, expertise, range and quality of service to customers, and shareholders' returns.

8   The present situation is not sustainable. Even if the Government does not liberalise the banking industry, local banks will be unable to maintain the status quo. Globalisation and electronic delivery channels have fundamentally altered the competitive landscape. Further rapid developments in Internet banking will enable foreign banks to reach out extensively to domestic consumers, reducing and eventually neutralising the advantages of an extensive branch network and Government protection.

9   Singapore has a well educated, English speaking, and increasingly computer savvy population, living in a compact city-state. This is quite unlike say France or Germany, where the language barrier and the size of the country make it much harder for foreign banks to gain a foothold. Our well-developed communications infrastructure also helps foreign banks access our market more easily. Singaporean banks can only hold their own against foreign competition by matching the quality and efficiency of the competition.

10   We must pro-actively manage the inevitable increase in competition, rather than try to keep out change, and thus lose both time and the initiative. Competition, not protection, is the best way to foster the development of strong and large local players. However, competition will not automatically solve our problem. Local banks must rise to the challenge, to develop and implement effective strategies to hold or increase their market share. They must attract and retain talent, strengthen management teams, institutionalise management processes, and improve systems of corporate governance. They also need to consolidate among themselves, and consider alliances with foreign partners who can offer new markets, products and technology.

11   In liberalising the banking sector, we seek a graduated shift towards greater competition and more free play for market forces. We want to shape and strengthen our banking sector, while maintaining confidence and stability in the financial system.

12   To achieve these ends, MAS will introduce a programme with the following elements:

• Five-year programme of liberalisation;
• Improving corporate governance practices; and
• Lifting the 40 per cent foreign shareholding limit.

FIVE-YEAR LIBERALISATION PACKAGE

13   MAS will implement a five-year programme to liberalise access by foreign banks to Singapore's domestic market. As the change is a major one, and there is no certainty as to how the industry will develop in Singapore and abroad over the next five years, MAS will commit to a definite package only for the first three years (1999 - 2001). Thereafter, MAS will review the progress made, before deciding on further liberalisation measures.

14   In this first step, MAS will open the door to new full and restricted banking licences, as well as increase access to the domestic market by foreign full, restricted and offshore banks that meet qualifying conditions, as set out in paragraph 22 below.

Full Banks

15   MAS will create a new category of full banking licence, to be known as Qualifying Full Banks (QFBs), to distinguish them from the existing class of foreign full banks. Incumbent foreign full banks that are not awarded QFB status will retain their existing privileges. All future admissions or upgrading to full bank status will be to the new QFB category.

16   MAS will issue up to 6 QFB licences to foreign banks over 1999 - 2001. Each QFB will be allowed additional branches, off-premise ATMs and ATM sharing, as follows:

• Up to 10 locations - branches ² and off-premise ATMs - of which up to 5 can be branches:
  • No more than 2 new branches and 3 off-premise ATMs to be set up each year following issuance of QFB licence;
  • QFBs which already have more than 5 branches will be capped at their present number, but will be allowed up to 5 off-premise ATMs;
• Free re-location of existing branches; and
• Sharing of ATMs among QFBs.

17   MAS will allow foreign full banks that are not QFBs to re-locate their existing sub-branches on a case by case basis.

Restricted Banks

18   MAS will increase the number of restricted banks from 13 currently to 18 by 2001. This will cater to offshore banks who want to expand their wholesale S$ banking business, but are not interested in the domestic retail business.

Offshore Banks

19   Offshore banks will be given greater flexibility in S$ wholesale business. Qualifying offshore banks approved by MAS will have their S$ lending limit increased from the current S$300 million to S$1 billion. They will also be allowed to engage in S$ swaps, without any restriction on the purpose of the swaps.

20   All other offshore banks will have their S$ lending limit raised to S$500 million. They will be allowed to engage in S$ swaps in respect of proceeds arising from the issue of S$ bonds managed or arranged by them.

Eligibility Conditions for Increased Access

21   MAS will not open the domestic retail market indiscriminately. It will grant increased access only to foreign banks that are strong and well-managed, and committed to growing in Singapore. This is necessary to maintain high prudential standards, minimise risk to local depositors, and develop a competitive financial centre.

22   The principles for evaluating applications for QFBs, restricted and qualifying offshore banks will be:

• Credit and legal support ratings of the institution over the last three years;
• Track record of compliance with MAS' regulations, and adequate internal control systems as determined by MAS' examiners or external auditors; and
• Commitment to contribute to Singapore's development as a financial centre.

CORPORATE GOVERNANCE

23   The Government has protected and nurtured the local banks, and enabled them to grow to their present size and strength, for a national purpose: to enhance the resilience and stability of our banking system. If the liberalisation weakens local banks and displaces them from their pivotal role in the domestic banking system, it will have failed. This has happened to some countries that opened up their domestic banking sectors. For example in Scandinavia, local banks over-extended themselves in the more intense competition, ran into serious trouble, and had to be bailed out by the governments. In New Zealand, all major local banks have been bought out by foreign parties, leaving no significant local players. This outcome is acceptable to New Zealand, but Singapore's circumstances are different.

24   We must ensure that the result of liberalisation is that local banks strengthen themselves and grow, so that they can continue to underpin the financial sector. To survive in the new environment, local banks must put increased emphasis on efficiency, quality of service and shareholder returns. Most important, they must strengthen corporate governance, attract top talent and give them the necessary mandate to make professional management decisions. Only then can they build up stronger corporate teams, and capabilities comparable to the major international banks operating in Asia.

Nominating Committees

25   The local banks need to institute systems for ensuring the appointment of capable individuals to their boards and key posts. To strengthen corporate governance, MAS will require all local banks to appoint Nominating Committees within their boards, and to provide for this in their Articles of Association.

26   The Nominating Committee will comprise five board members. Their appointments will be made by the board, and subject to MAS' approval. The purpose of the Committee is to ensure that only the most competent individuals, who can contribute to the bank and discharge their responsibilities in the interests of all shareholders, are appointed to the board and key management positions.

27   MAS will issue a notice to local banks to spell out the roles and functions of the Nominating Committee. The Nominating Committee will be responsible for identifying candidates and reviewing all nominations (by the board or shareholders) for the following positions:

• Board membership (for both appointment or re-appointment);
• The Executive Committee of the board;
• The Compensation Committee (local banks presently without such a committee or its equivalent will be required to set one up);
• The Audit Committee;
• The Chief Executive Officer / Deputy Chief Executive Officer / President / Deputy President; and
• Chief Financial Officer.
• The names recommended by the Nominating Committee will be then decided upon as usual, by the board or share-holders as appropriate.

28   In identifying candidates and reviewing nominations, the Nominating Committee will apply the following guidelines:

• The board should comprise a majority of Singapore citizens or permanent residents;
• The board should have a majority of independent directors who are not related to or employed by substantial share-holders of the bank (those holding 5 per cent or more), or who otherwise act in accordance with their directions;
• Besides the customary criteria of integrity and being a fit and proper person, the Nominating Committee must consider the age, experience and capabilities of the nominee; and
• The Nominating Committee must satisfy itself that the candidate is the best and most qualified candidate for the job, especially for appointments to key posts.

29   MAS will retain its existing powers under the Banking Act to approve appointments to the board, and to key posts like the CEO and Deputy CEO. Hence-forth, re-appointments will also require MAS' approval, so as to ensure that candidates who may first have been appointed some time ago continue to meet the criteria for appointment.

30   MAS may ask the Nominating Committee to submit records of its deliberations and proceedings, so as to verify that the Committee has been diligent in trying to enlist the best person for any appointment.

31   The proposal to create Nominating Committees has international precedents. About half of US companies have Nominating Committees with very similar roles, including banks like Citigroup and First Union. The UK Cadbury Report on Corporate Governance also recommended the setting up of a Nominating Committee comprising a majority of non-executive directors and chaired by the Chairman or a non-executive director, to propose to the board, in the first instance, any new appointments of either executive or non-executive directors.

FOREIGN SHAREHOLDING LIMIT OF LOCAL BANKS

32   MAS currently restricts foreign investors' total shareholding in local banks to no more than 40 per cent of the issued shares. The purpose is to ensure that those who exercise control over local banks have national interests in mind. The policy was introduced in 1971 following the Slater Walker - Haw Par affair. The limit was initially 20 per cent, and was later raised to 40 per cent in 1990. This limit has since been incorporated into the Articles of Association of local banks.

33   The concern that local banks should give priority to the national interest remains valid. However, the foreign shareholding limit has signifi-cant drawbacks:

• It has resulted in a two-tier market for local banks' shares, and reduced liquidity in the local share tranches;
• It has distorted the true market value of local bank shares, and raised the cost of funds to banks;
• It has made it harder for local banks to implement competitive employee share option schemes; and
• It has hindered local banks that want to forge strategic partnerships with foreign banks, or pay for overseas acquisitions with shares.

34. MAS will lift the 40 per cent foreign shareholding limit on local banks. The requirement to create Nominating Committees, and to have a majority of citizens and permanent residents on the board, will effectively ensure that control of the banks rests with individuals or groups who will act in a manner consistent with the national interest. In addition, MAS will tighten existing safeguards on the accumulation of significant ownership in a local bank:

• At present, any individual shareholder or group of associated shareholders must obtain MAS' approval to increase his shareholding beyond two thresholds - 5 per cent and 20 per cent. MAS will now introduce an additional approval threshold of 12 per cent.
  • MAS will approve increases in shareholding beyond 5 per cent only in significant transactions that are considered beneficial to the bank and to Singapore.
  • Approval to exceed the 5, 12 or 20 per cent shareholding levels may be accompanied by such conditions as MAS considers necessary in order to prevent undue control and to protect national interests. This may include limits on further increases in shareholding for a specific period of time.
• MAS will expand and clarify the definition of collusion under the Banking Act.
• MAS will consider further deterrent measures, including powers to disenfranchise a shareholder or a group of share-holders found to have colluded to circumvent the shareholding approval thresholds.

35. MAS will allow individual local banks to remove the 40 per cent foreign ownership limit from their Articles of Association, once they have amended their Articles to institute Nominating Committees. Local banks with dual tranches will issue announcements shortly on whether and how they intend to do so.

REGULATORY FLEXIBILITY FOR LOCAL BANKS

36   MAS will review all regulations concerning local banks so as to give them greater flexibility in their operations without compromising prudential objectives. This will include the minimum capital adequacy ratio requirements for the banks and their subsidiaries. This will enable local banks to compete more effectively as we liberalise and increase the level of competition. MAS will consult with local banks in this review.

37   As an immediate measure, MAS will issue guidelines to allow local banks to set up a financial holding company structure. Financial holding companies will be licensed and supervised by the MAS. This structure will provide local banks with greater flexibility in organising their operations, especially as they venture abroad, and in forming strategic alliances with foreign banks while allowing both banks to maintain separate legal identities and franchises.

RETAINING A SIGNIFICANT LOCAL BANK PRESENCE

Market Share

38. While we encourage strong and well-managed foreign institutions to assume larger stakes in the growth and stability of our financial system, we want local banks to retain a significant portion of the domestic deposit base and payments system in the more open environment. In a major crisis, we must be able to count on major players with long term interests aligned with the Singapore economy, to act as stabilisers for our financial system.

39   In developed markets, domestic banks typically have a much larger share of the market than is the case in Singapore ³. Our local banks presently have 62 per cent of total resident deposits (both DBU and ACU). Their share peaked in 1994 and has been declining since.

40   The Government's policy is to maintain the local banks' share at not less than 50 per cent of total resident deposits. We will monitor the trends as the liberalisation proceeds, and if necessary adjust the scope and pace of subsequent liberalisation measures to achieve this. But there can be no absolute guarantee that local banks will maintain a 50 per cent market share. The best way is for local banks to upgrade themselves and hold their own against stronger competition. This in turn will most probably require consolidation within the industry.

Consolidation

41   In the existing protected environment, local banks have competed among themselves by proliferating branches and ATMs, and maintaining separate but similar support services. The result is duplicated infra-structure and attendant inefficiencies. The liberalisation will make more urgent the need for banks to consolidate. This will enable them to rationalise these overlaps, and share common back-office systems and delivery channels.

42   Consolidation yields important benefits beyond such one-time savings:

• It will give the banks larger economies of scale to defray high initial costs of technology, and to cross sell a wider range of products;
• It will also give banks the size to venture forth in the region, make acquisitions and strike alliances, should this be their business strategy; and
• It will conserve scarce management talent, and help banks to attract more talent. Able people are attracted to larger banks of an international standing, with growth prospects domestically and abroad. Smaller banks with lesser prospects for expansion cannot recruit high calibre executives.

43   This is why the Government has encouraged local banks to consolidate among themselves, to achieve that critical size for continuing expansion and growth. The Government has taken the lead, by merging POSB with DBS. However, it cannot dictate the precise configuration that results from further consolidation. Only the shareholders can decide on mergers between local banks.

44   The smallness of our domestic market, and the growing economies of scale in banking, make it unlikely that Singapore can sustain more than two local banks with that critical size, although there may be other smaller players occupying niche markets. If we succeed in building up two such strong local banks, our financial system will have two pillars of strength and stability.

CONCLUSION

45   The Government has calibrated the pace and extent of liberalisation to inject competition and a sense of urgency, yet allow local banks time to strengthen and reposition themselves. Our objective is a more competitive industry, with stronger local banks maintaining more than 50 per cent of the market. There is no assurance that liberali-sation will succeed. Even in ideal circumstances, it is not easy for banks in a small country to grow and upgrade, much less at a time of rapid change and worldwide consolidation in the industry. But the risk of not proceeding is greater. Our banks will be progressively marginalised if they do not act now.

46   As this is a major and irrevocable decision, the Government has taken time to study the matter thoroughly, and to discuss the issues extensively with the local banks. The local banks understand the objective of the exercise, the challenges they face, and what is at stake. The Government is confident that they will strive to transform themselves in order to meet the challenges of a new banking environment.

¹ Full banks are permitted to carry out the whole range of banking activities.

Restricted banks are constrained from operating Singapore dollar savings accounts and accepting individual fixed deposits of less than S$250,000 from non-bank customers.

Offshore banks are not allowed to accept interest-bearing Singapore dollar deposits from persons other than approved financial institutions; or extend credit facilities to resident non-bank customers in excess of S$300 million. Restricted and offshore banks are also restricted to only one main branch.

² Branches include both the main office and sub-branches.

³ The leading domestic banks alone typically have between 40 - 60 per cent of their home market deposits. In Canada and Australia, the concentration is even higher - the big four Canadian banks have about 70 per cent market share, while the percentage for Australia's big four stands around 68 per cent. In Hong Kong, the HSBC group and Bank of China together have about 55 per cent share of the Hong Kong market.

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