Case Study

Global success with electronic banking: the Hongkong Bank and HEXAGON

Maris G. Martinsons

Fellow, Poon Kam Kai Institute of Management, University of Hong Kong, and Fenior Lecturer, Faculty of Business, City Polytechnic of Hong Kong*

The recent performance of the banking industry has been mediocre despite (or perhaps because of) a massive investment in information technology. Globalization initiatives within the industry have been particularly susceptible to failure. This article describes the unique success of the Hongkong Bank and focuses on the strategic support provided by its private electronic banking system. Using this system, this bank has leveraged its reputation and infrastructure in the developing economies of Asia to rapidly become a major international bank without developing an extensive new branch network. The benefits of the HEXAGON system and its impacts on international banking are discussed.

Keywords: inter-organizational information systems, electronic banking, globalization

Financial services has traditionally been a highly fragmented industry, with banks providing a limited range of products within narrow geographic boundaries. More recently, government deregulation and techno- logical progress have opened up the market for these products, creating keen competition and transforming banking into a discrete part of the information services industry.

Information technology has become an integral part of progress in banking. Computers and telecommuni- cations have enabled a wider selection of services, with greater speed and convenience. Time-consuming procedures have been streamlined and information ‘floats’, the time lags between the dispatch and receipt of transaction-related data. have been reduced. Efficiency and effectiveness have improved as banks process increasing transaction volumes at lower costs per unit.

Success with information technology has become not only necessary for a bank’s survival but also offers a potential competitive edge. With the technological gap between industry leaders and laggards widening, individual IT infrastructures have taken on a greater strategic importance, while their overall shape and form is starting to affect the structure and competitive balance of the whole banking industry’.

*Contact address: Business and Management Department. 83 Tat Chee Avenue. Kowloon Tong, Hong Kong

Information technology initiatives have institution- alized automated teller machines (ATMs), computerized many back-office banking activities and popularized the use of inter-organizational electronic banking. Such electronic banking systems give customers instantaneous access to bank services around the clock, from either their home or office, and with global links, from anywhere in the world. With such availability outside the traditional branch network, technology has become a third competitive weapon in banking, being added to branch location and corporate image2.

International banking

International banking emerged as a viable business activity in the 1960s as a result of rapid developments in information technology and the following other factors:

the progressive removal of national and regional regulations the increasing international scale of corporate customers the globalization of markets for debt and, increas- ingly, equity around the clock financial trading securitization (the conversion of developing country debt into marketable securities), and increasing innovation in financial services manage- ment.

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Today, international banking is a hybrid between a multinational industry, where products and services are tailored to national markets, and a global industry, where there are similar bases of competition across all the markets3. Growing rivalries and reduced profit margins in banking are consistent with Porter’s framework of intense international competition4.

Globalization has lost much of its popularity and profitability among bankers. Many major institutions, such as Bank America and Lloyds Bank, have retrenched after losing money in attempts to expand geographically. However, the Hongkong Bank has been exceptionally successful, aggressively expanding from a strong and profitable business base in the faster- growth developing economies in South-east Asia.

The Hongkong Bank

The Hongkong Bank (HKB) was established in 1865. After its merger with the Midland Bank, it is among the 10 largest bank groups in the world, with assets of about US $300 billion. In contrast to other Asian banks, it has recently pursued a three-pronged global strategy, moving towards a significant presence in Europe and North America. Acquisitions in strategic locations and expansions of its own operations have created a globe- spanning network to generate trade finance and treasury revenues. By early 1992, the Hongkong Bank was ‘the bank with the highest proportion of its assets overseas’5. A regional distribution of assets is shown in Table 1.

HKB believes it can and should become an inter- national operation with semi-autonomous branches providing indigenous banking services in each of the worlds main financial markets. This international diversification is only partly in response to the uncertainties (and potential exodus of investment capital) associated with the 1997 transfer of Hongkong. With the People’s Republic of China regaining sovereignty of the banks traditional home base from Britain, HKB faces the unique problem of operating as a global capitalist bank from a sovereign communist country. Not surprisingly, it is preparing for the possibility of turbulence in its home market. For example, a rare non-resident UK-domiciled company replaced the Hongkong & Shanghai Banking Cor- poration as the bank group’s umbrella corporation in 1990.

The Hongkong Bank has specialized in trade tinance and played a key role in financing Hong Kong’s explosive postwar growth. It continues to hold 60 per cent of the local banking market and serves as the territorial government’s banker. Significant business

Table 1. The Hongkong Bank’s distribution of assets by region (percentages)

1989 1992

Asia Pacific 48 39 Americas 30 22 Middle East/Africa 4 5 Europe 18 34

[Source: Hoover. G, Campbell, A and Spain, P .I (Eds) Hoovered Handbook: Pro/ile.s ~/Over 500 Major Corpororions Reference Press. Austin. TX ( 199l)j

penetration across Asia did not occur until the 1950s coinciding with the banks withdrawal from China after that country’s communist takeover.

HKB’s combination of acquisitions and expansions have brought a steady stream of rising annual profits in the growing economies of the Far East, and more recently the Middle East. It is now the best positioned major institution to finance the (future) growth of China, a country with 1.2 billion potential bank customers. Simultaneously, the bank has placed a growing emphasis on customer relations throughout Asia. This is part of a general movement toward a cross- cultural and ultimately Western-style management, and in particular, an attempt to capitalize on the growth of South-east Asian securities markets which has boosted the custodial banking market.

By 1988 the Hongkong Bank had completed a takeover of the New York-state based Marine Midland Bank, making it the largest foreign-owned bank in the United States. A strategic alliance with the Wells Fargo Bank of California represents the first venture in the western USA. Meanwhile, the Hongkong Bank of Canada has benefited from that country’s financial deregulation in 1987 and prospered through its acqui- sitions of the Canadian Commercial Bank, the Bank of British Columbia and the Lloyds Bank of Canada. It is now Canada’s leading foreign-based bank, ranking seventh overall with assets exceeding US $9 billion.

The Hongkong Banks initial attempts to establish a European foothold were foiled when the British government, citing the banks international orientation, blocked a bid for the Royal Bank of Scotland. However, in 1987 it acquired 14.9 per cent of the Midland Bank. The latter had been the worlds largest bank in the 1930s and was still one of the UK’s big four banks. Five years later, the Hongkong Bank merged with the Midland Bank, combining their assets of about US $180 billion and $105 billion, respectively.

Global integration

Merger success often depends on consolidating networks and information systems to achieve operational savings. This will be particularly important in the marriage between HKB and the Midland Bank. Although two banks in the same market can boost their collective performance by combining operations and reducing staff, there is little overlap between the European activities of Midland and those of the HKB group in Asia and North America.

However, corporate management believes that the new Hongkong Bank can capitalize on its ability to finance the growing cross-continental trade and invest- ment flows of Europe, America and Asia. By serving customers’ overseas needs, domestic client business can be more easily retained. As a major corporate banker in both the developed and developing worlds, the bank will have to be a competitive and cost-efficient provider oftrade finance and commercial banking services, and display an organizational ability to manage rapid change in response to environmental development$.

Fortunately, HKB’s recent track record bodes well for the future. Amidst a general malaise in financial services in the period from 1988 to 1992, it achieved steady and significant growth in both profits and return on investment by leveraging and enhancing significant

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economies of scale and scope, particularly in the areas oftechnology and systems. Its real costs per transaction have declined by nearly 15 per cent in the same period. Largely because of its information technology leader- ship, ‘Hongkong Bank’s operating costs are (a remark- able) 25% lower than those of comparable Western banks”.

Hongkong Banks managers recognize that excellence in information technology is a critical factor for success in global banking. The bank has used global information technology to coordinate and control its worldwide operations and togain direct competitive advantages in various markets’. The banks automatic teller machine system, called ETC, can be accessed by customers on four continents while its advanced treasury trading system,. TREATS, automates backroom work and creates risk profiles. cash flows and forward ladders to support financial dealers in the worlds major centres.

HEXAGON: a global electronic banking system

For its globalization strategy, the Hongkong Bank has relied extensively on an information system called HEXAGON. As shown in Figure 1, it is a global electronic banking system (GEBS) with an integrated data network, which electronically links customers to the bank.

The HEXAGON system was initiated to help the bank combat soaring operating costs and to give it flexibility in meeting the needs of multi-national customers. It was also viewed as a major innovation in HKB’s transformation from a traditional money bank to a modern information bank in the early 1980s. Interestingly, the corporate board supported the proposed electronic banking initiative despite the fact that those individuals were relatively unfamiliar with, let alone users of, computers or telecommunications. IT innovations, such as the treasury management system, were pursued because they were both possible and advisable, and implementation has been carefully planned to meet strategic objectives while ensuring that both staff and customers successfully adapt to the technological change.

Although BT North America provided some of the technology for the global network, HEXAGON was largely planned and developed in-house by EDP and telecommunications staff after a build or buy analysis similar to that described by Martinsons’. The initial development, from 1982 to 1985, cost about US $100 million and was divided into two aspects: applying telecommunications technology to create an ‘electronic’ window for customers, and augmenting HKB’s existing information processing capabilities.

HEXAGON was introduced in 1985 to the banks

Customer’s Office I I Bank

Figure 1. HEXAGON links to the customer

corporate customers in 15 countries. Electronic banking was well-received, especially by organizations across the Southeast Asia, which favour comparatively small investments in simple and well-proven technologies. A further 10 countries were connected to this private network in 1987, with national extensions and regional networks periodically being upgraded and expanded since that time.

HEXAGON now handles an annual volume of US $350 billion in transactions. Nearly 5000 corporate customers throughout the world are linked to the main HEXAGON databases through the bank’s 38 regional information processing centres in 29 countries. HEXAGON has about one-third of the worlds 200 largest corporations as subscribers, with major industries including: security trading, retailing, govern- ment, high-technology manufacturing, import/export and transport. These clients commonly have the following characteristics:

multinational companies companies with operations at some distance from a HKB branch companies making frequent market and account enquiries companies making numerous fund transfers or payments firms engaged in trade finance as an integral part of their business firms active in stock markets as an integral part of their business firms already using microcomputer technology in their offices.

HEXAGON services are available to anyone having an IBM-type personal computer with a modem and making a nominal monthly service fee payment (currently US $12). The modem from a client PC connects to the Global Data Network (GDN) through public telephone lines, while dedicated communication lines join the private network with the HEXAGON databases.

Once logged on, a customer can utilize all the HEXAGON services through the PC connection. The customer’s computer screen becomes a window through which corporate finances and market information can be viewed and transactions made. Since HEXAGON supplies timely global information (interest rates), customers can perform worldwide financial comparison shopping. The customer office effectively becomes a branch of the bank which is open around the clock.

The HEXAGON global electronic banking system is menu driven, with a hierarchical listing of the available options on a series of screens. A ‘main menu’ lists all the available HEXAGON products and subsequent screens list all the services for the selected product. Information/input screens for each service enable users to execute their transactions.

HEM GON services

The services currently offered by HEXAGON represent a considerable evolution and progression from its first inter-organizational links, which facilitated electronic cash management for customers. HEXAGON products may be divided into two categories, banking products and management products, as shown in Figure 2.

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Banking Products Account Information Payments Authorization Portfolio Management Current Accounts Savings Account Documentary Credits StatementKheque Electronic Mail Securities Exports Time Deposits Foreign Exchange Transfers Imports Viewtext Market Information

Management Products Authorization Management Control Batch Transfer Unattended Operation Fast Path

Figure 2. HEXAGONbanking and management products

This GEBS provides access to three types of services:

(1) Corporate finance Customers can get updated information about their accounts and finances on a global basis. They can call up: the balance of each account with the bank: their import/export positions, including the amounts and due dates for outstanding bills; their foreign exchange position, including a valuation of contracts using the latest forward rates; their time deposit portfolio, as well as portfolio summaries and recent transactions with the following HKB group associated companies: Wardley Investment Services, Hongkong Bank Trustee, and James Cape1 Ltd.

(2) Market information Customers can obtain a variety of information about local and global security and commodity markets. The regularly updated quotations include currency notes and demand draft rates, deposit and foreign exchange rates, interbank lending rates, precious metal prices, stock market indices and share prices as well as foreign exchange and macroeconomic commentaries, major corporate announcements and market commentaries.

(3) Banking transactions The customer can make single or multiple payments or transfers in any currency to another Hongkong Bank account anywhere in the world, apply to open or amend documentary credits (DCs), and place funds on deposit. Transaction details are automatically stored on the system and can be used to trigger subsequent automatic payments. Security sale or purchase orders may be initiated, together with receipt and delivery instructions or enquiries about the status of orders - transacted, settled, outstanding or overdue. Customers can also batch transfer transactions which have been prepared in bulk, under the off-line facility, to the main bank computer for processing.

An electronic mail facility enables communications which may be used by customers to make general enquiries, request account audit statements and order new cheque books. Viewtext provides on-line infor- mation services, such as user instructions and market briefings while a Fast Path option can automate many HEXAGON procedures for enquiries (but not trans-

actions) which have to be conducted regularly. Customers can quickly set up instructions or retrieve ones already stored. Information which is automatically transferred at pre-set times, usually overnight, enables the customer to use off-peak telephone charge periods to retrieve HEXAGON data without being physically present at their PC.

Security

Since HEXAGON can handle different business affairs for its customers, much of the transacted information may be confidential. Disclosure to or alteration by unauthorized parties may create disastrous results. Thus, comprehensive security measures are required. The built-in security features in HEXAGON may be divided into (a) systems security, (b) operations security and (c) management control.

The HEXAGON system and its associated communi- cations network, the Global Data Network, are owned and operated by the Hongkong Bank group. Therefore, access to the core of the system can be carefully controlled. Furthermore, the information passing between the PC and the bank’s computer is encoded, reducing the possibility of, or advantage to viewing or modifying any transmission data. Potential HEXAGON users must identify themselves by successfully completing a series of password checks.

Access to HEXAGON is only allowed to nominated delegates when they enter their personal password and a session password (generated during the previous session) correctly. To prevent access by trial and error, a delegate is disconnected after four unsuccessful sign- on attempts. Unless that delegate re-registers, they can not access the system again. HEXAGON also auto- matically terminates a session if there is no keyboard activity for 5 minutes, to help prevent system abuse when the delegate temporarily leaves the linked PC.

A management control option enables the client organization to monitor and control its use of HEXAGON. Senior management may specify users and their usage, by setting limits on transactions that can be performed, by specifying the authorization for classes of transactions and monitoring the activities undertaken through HEXAGON. An ‘Activity Review’ enables audits of suspected misuse in the client organization.

Designated individuals can change the passwords and restrict payments to specific beneticiaries. The ‘management control’ and ‘authorization’ features permit HEXAGON access to be tailored to the client’s internal checking and control policies and working procedures. These security measures may be termed sufficient and comprehensive, in that Hongkong Bank officials have not acknowledged any significant abuses of HEXAGON to date.

HEXAGON benefits

This global electronic banking system is an example of an information system which is at the interface of the value-added chains for the bank and its customers, The benefits to both the bank and its customers may be discussed in terms of Porter’s value chain concept.

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support Activities

Infrastructure

Human Resources

Technology

Primary Activities

Figure 3. A global electronic ban king system increases the effectiveness of each support activity in Porter’s value chain

Customer benefits

The value chain of a firm comprises both primary activities,’ directly creating products or services and transferring them to the customer, and support activities, which aid the operations of the primary ones”. The major role of this GEBS is to make each of the

In terms of improving infrastructure support, HEXAGON compresses time and distance for inter-

customer support activities, shown in Figure 3, more

organizational activities, thereby increasing the likeli- hood of such communications while lowering the

efficient, by lowering its costs.

overall coordination costs. At the strategic level, it is a good decision support system, providing extensive market information (external) and accounts information (internal) for managers. This comprehensive output can assist in making investment and loan decisions (external) as well as financial control and planning (internal). The quality of the decision is improved through more timely and comprehensive information.

The extensive information provided by HEXAGON can actually trigger management planning and strategy development. It can improve the efficiency and effectiveness ofdecisions by reducing the cost and time needed for ad hoc searches, and increases the reliability and accuracy of the resulting information. As an example, some managers use HEXAGON to shop around the world for the most attractive interest rate on a specific time deposit.

HEXAGON’s financial and economic commentaries and forecasts help managers plan for the future while its timely information enables clients to respond quicker in a turbulent business world, capitalizing on opportunities and thwarting potential threats. Cash management has always been the most popular client activity on HEXAGON, with the on-demand access to an electronic banking window being greatly valued by corporate treasury departments.

Larger clients can consolidate information from many accounts around the world and unlike a treasury workstation, there is no expensive software on the client PC.

At the tactical level, information provided by the GEBS helps control and monitor activities, by tracking all the transactions undertaken within the past 30 days. Operational staff can carry out traditional banking activities via HEXAGON rather than via telephone or in person.

Human resource support savings come from executing financial transactions through the customer PC, reducing clerical staff and messenger requirements.

The information provided by HEXAGON is also relatively more efficient and error-free. This reduces the time spent gathering and verifying data, leaving more time for higher value tasks.

Access to this system has often acted as a catalyst for a client’s own information system developments, thereby increasing the value of technology support activities. Users may be motivated to champion IS progress within their firm to enhance the value of their HEXAGON subscription or increase the efficiency of internal operations. As an example, a payroll system connected with HEXAGON can calculate the pay for employees and forward this information to HKB in a batch transfer mode. Automatic transfers can then be made from the tirm’s account to the employees’ accounts.

Purchasing is the fourth value-chain support activity identified by Porter. For clients who are actively engaged in international trade, HEXAGON can streamline the purchasing process. It simplifies the time-consuming procedures of applying for docu- mentary credits and enables electronic fund transfers between the buyer and supplier.

In its marketing, HKB emphasizes the compatibility of its global electronic banking system with existing ways of doing business. HEXAGON is promoted as (a) fitting well with existing relationships between cor- porations and especially their senior executives, and (b) helping to improve (not change) existing patterns of business operations.

Bank benefits

HKB is using HEXAGON to leverage its dominance in the developing economies of Asia, its geographical diversity and key structural resources to become a truly global bank. Many of the system’s benefits to the bank may be considered in terms of Porter’s competitive forces”: suppliers, existing competitors and new entrants, substitute products and buyers, as described below.

HEXAGON is part of a corporate initiative to link the entire organization electronically, enabling more efficient and less expensive information delivery and reducing HKB’s reliance on an important supplier - labour. It has helped insulate the bank from the operational-level labour shortages which have become common across Southeast Asia.

HKB is pursuing its global strategy with an approach similar to that employed by the Bank of Scotland when it expanded southward into England’*. Both are using information technology as a partial substitute for an extensive branch network in serving their new markets. In both cases, prohibitive investments in a brick and mortar infrastructure and the considerable times for completion were avoided.

The success of HEXAGON has given the Hongkong Bank considerable control ofthis distribution channel, thus reducing the threat of new competitors in the global banking industry. A GEBS (or sub-contracting of such a network) is an essential part of a global banking strategy. However, this strategic system requires a huge hardware investment as well as considerable system design and maintenance expertise. Once in place, its marginal costs relative to manual systems are very small, providing significant economies of scale.

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Thus, only large banks with an extensive customer base, sound finances and competent technical support can construct such an information system and benefit from it.

Two types of substitutions are possible among HEXAGON customers: a move to another system (entailing switching costs) and substitution by other products. However, HEXAGON subscribers indicate that they have commonly made the GEBS an integral part of their operations. They would be reluctant to transfer to other systems, because of the switching costs, largely in terms of retraining and adaptation, that are associated with such a change. The international operations and dependence on trade financing of many GEBS customers also limit their alternatives. Since the available services are similar with each system, a customer will have difficulty justifying a switch of their operations from one bank to another.

While microeconomic theory indicates that only a fair return on capital assets is possible in a competitive market, this system is enabling the Hongkong Bank to create entry barriers and enjoy superior ‘rents’ from its technological innovation. HKB has reduced the threat of substitute products by (1) introducing a fairly comprehensive and user-friendly system, making it attractive to potential customers and difficult for competitors to emulate, and (2) making on-going efforts to improve system performance while regularly adding new features.

The attractive pricing and user-friendliness of this GEBS has increased the cost-efficiency of client operations and has proved to be an effective tool for attracting customers to the bank (even from competitors). Meanwhile, HKB has enjoyed savings in human resource and physical space requirements and a reduced need to duplicate its physical resources in new markets while creating the flexibility to rapidly extend its business scope (by making additional services available to existing subscribers via electronic banking).

The bottom line

HEXAGON strategically supports the Hongkong Banks globalization initiative. It enables the bank to keep costs down while leveraging its trade finance and customer relation strengths. The innovative product line which is possible with electronic banking helps HKB consolidate and sustain these competitive advan- tages. While HEXAGON has provided first-mover advantages in some regional markets, which can be nurtured for an ongoing competitive edge, more generally it has enabled cost efficiencies and eased manpower shortages.

HEXAGON facilitates a reliable banking link for international clients, reducing the need for local duplication of banking resources. Furthermore, its around the clock accessibility has increased customer convenience and the banks utilization of resources. However, the strategic benefits of using HEXAGON to become a truly global bank are only now starting to be fully realized.

Continued reductions in the costs of PCs and associated information technology hardware will lead to a greater number of smaller-sized businesses automating their operations. At the same time, the interdependence of national and regional economies

continues to grow. Greater numbers of enterprises are becoming multinational or global. This combination can be expected to dramatically increase the market for global electronic banking. However, the enormous investment costs will inhibit the development of new inter-organizational systems on a global scale. Inter- national banking clients will choose from a limited number of suppliers. As an early adopter of a private global electronic network, the Hongkong Bank has enjoyed certain efficiencies and first-mover advantages while establishing a strong presence among global banking clients.

HEXAGON and the banks other systems have given it ‘the acceptance of other banks of its significant technical leadership’ position in a competitive industry’. With electronic links, emphasizing products rather than price, already achieving a strategic impact in the airline industry, HKB hopes for similar results. To date, Wells Fargo Bank (USA) and several medium-sized Asian banks have signed agreements to deliver their banking services through the Hongkong Banks system. At the same time, with integrated services digital network standards (ISDN), integrated banking systems (IBS) and shared electronic networks at various stages of development, HKB management recognizes that HEXAGON may face increased threats of substitution in the future.

As personal contacts between banks and customers are reduced through the increased use of GEBS, banking services have become more depersonalized and non-differentiated. The Hongkong Bank is also moving to address this problem. As part of a customer relations focus, personal consultation services are being established and private banking marketed to wealthier clients in order to support differentiation. With most customers rarely meeting their bankers, there are limited opportunities to woo additional business from them. The Hongkong Bank is keeping its name in the public eye by sponsoring cultural and sporting events and using direct mail.

To underscore its commitment to new delivery mechanisms, the Hongkong Bank continues to progressively underinvest in its branch network while centralizing its processing operations and using the existing infrastructure as a ‘cash cow’to support further investments in emerging technologies. With the under- lying technology now widely available, major banks with global electronic networks will be able to offer similarly accurate and timely information quickly in an efficient and effective manner. On-going investments will be needed to sustain advantages. The Hongkong Bank is committed to ploughing back profits, especially from the developing world, to respond to technological and competitive changes in order to sustain the advantage from its early GEBS development.

Acknowledgement The author wishes to thank Paul Chan Kei-Yan for his research assistance and managers at the Hongkong Bank for their cooperation in this case study.

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