The Hong Kong Monetary Authority (HKMA) recently granted a number of licenses to virtual banks in the city. But what exactly are they? Put simply, virtual banks are financial institutions that operate without physical branches.

With transactions taking place over the internet, smartphones, or other electronic channels, virtual banks can provide the same services traditional retail banks offer, including loan and credit card applications, while leveraging existing ATMs for cash deposits and withdrawals.

Central district of Hong Kong

Image Source: Getty Images.

But without paying rent in the world's most expensive property market, Hong Kong's virtual banks can offer customers much more competitive rates than their traditional brick-and-mortar counterparts.

Implications for traditional banks 

Virtual banks have yet to commence operations but their disruption is already being felt. Hong Kong's traditional retail banks, including HSBC Holdings plc (SEHK: 0005)Hang Seng Bank Ltd (SEHK: 00011) and BOC Hong Kong Holdings Ltd (SEHK: 02388), have removed fees on entry accounts that require a minimum balance holding in anticipation of their entry.

While the new entrants add to the industry competition, the economic climate is a bigger factor for banks. The HKMA's decision to cut interest rates in August further tightens net interest margins for banks, which averaged 1.6% at the end of 2018.

Amid fewer earnings drivers, cost control becomes key for stock prices. Recently, HSBC's announcement to cut 2% of its workforce follows other financial institutions looking to trim expenses and channel more investments into fintech infrastructure.

Should shareholders be worried?

Hong Kong banks have always been attractive investments, particularly HSBC which offers a dividend yield upwards of 6%. But as customers become the big winner of virtual banks, does this imply that traditional banks will certainly lose?

Not necessarily. Early estimates forecast the first eight new entrants may reach a combined profit of 7% of HSBC in five years, while other estimates around 10% of existing bank revenues are at risk over the next decade. But Hong Kong's largest banks are well prepared, including HSBC – which conducts 80% of its retail banking through digital channels.

The Foolish takeaway

More broadly, with the new virtual players averaging HK$1.9 billion in paid-up capital (more than the HK$300 million required) you can expect bank customers to enjoy the benefits of industry competition for a while.

But going forward, Hong Kong's traditional banks will need to issue larger loans amid slower growth in both China and Hong Kong where credit demand is anemic. I believe virtual banks are unlikely to disrupt their dividend payouts but the economic environment just might.

A version of this article originally appeared on our Fool Asia site. For more coverage like this head over to