THE HONGKONG & SHANGHAI BANKING CORPORATION CASE

Introduction

HongKong & Shanghai Banking Corporation (HSBC) was the world’s thirtieth-largest bank in 1980. Based in Hong Kong, the bank has carried out most of its business in Hong Kong dollars and U.S. dollars, with substantial amounts of business in European currencies and Japanese yen as well. It has received deposits from local (Chinese) individuals and companies, and has loaned the money to both local borrowers and international banks in the so-called eurocurrency market. HSBC has specialized in financing exports and imports, largely with firms in countries of the British Commonwealth (great Britain and its former colonies). The vast majority of the bank’s business has been done physically in Hong Kong, though it has a very large London branch office and several U.S. branches New York. (The representative office is not allowed to do business directly; under U.S. law it has had to refer all clients to the California subsidiary bank, the London branch, or the Hong Kong headquarters.)

In 1980 the bank was looking to expand in the U.S. market. Its dealings in the eurocurrency market had led to large deposits of U.S. dollars, British pounds, and other currencies, which the bank needed to lend to borrowers somewhere. Rather than continue to accept low profits from lending these funds to other banks, HSBC decided to seek new borrowers in the world’s largest market, the United States. Although HSBC had over a century of experience in international banking, it had never considered a major move into the U.S. domestic market. In the late 1970s, at a time when their British pounds, deutsche marks, and Japanese yen could buy far more dollars than in the 1950s and 1960s, many of the bank’s clients were establishing offices, factories, and other investments in the United States.

The bank also was interested in moving into the U.S. market as a hedge against the substantial risk of nationalization by the Chinese government. In 1997 the British colony of Hong Kong is scheduled to return to Chinese ownership, which will bring with it the possibility of major legal changes in rules for business. Because the People’s Republic of China is a communist country, many observers expect Hong Kong to lose its free market status. As the largest bank in the colony, HSBC faces very likely changes in its business activities. For this reason, the bank’s managers and owners have been interested in establishing domestic activities in the United States, generally viewed as the least politically risky environment in the world.

In addition to having substantial deposits in several currencies and clients of several nationalities, the bank possessed another competitive strength—namely, its large staff of experienced bankers who knew about both lending and borrowing opportunities in Asia that were not well known to potential U.S. clients. By operating directly in the U.S. market, the bank would be able to take advantage of this expertise to earn additional profits.

HSBC has been operating in the United States since 1875, when it opened an agency in San Francisco. A second agency was opened in New York in 1880. The New York agency was converted into a branch in the 1970s, as a result of exchange in New York’s banking laws. In the 1960s HSBC acquired the Republic Bank of California, which had eleven branches in the state. The bank was renamed the HongKong Bank of California. Other branches were established in Chicago, Seattle, and Portland, and another subsidiary was set up in Houston, Under U.S. banking rules in 1980, if HSBC wanted to open a full-service subsidiary in any other state, then the California branch network and the Houston subsidiary would have to be divested.

The Case

Mr. Michael Sandberg, chairman of HSBC in Hong Kong, was considering the alternatives for expanding in the U.S. market in 1980. The top management of the bank wanted to diversify its assets and activities across the world, placing about one third of the total in Hong Kong, Europe, and the United States. Sandberg felt that it would be possible to set up an agency in New York, where over 90 percent of the international banking in the United States takes place. Similarly, it would be feasible to establish a branch bank, owned completely by HSBC and using a federal U.S. charter under the existing U.S. laws. Additional representative offices could be placed in cities other than New York, but these facilities would be restricted to providing information to potential clients, who still would need to do business with HSBC in San Francisco, London, or elsewhere outside of the United States. Finally, Sandberg considered the idea of forming a joint venture with an existing U.S. bank, which would give HSBC immediate access to new clients and partial ownership and control of the venture. Each of these alternatives is discussed in more detail below.

Setting up an agency would allow HSBC to minimize the capital needed to enter the U.S. market, since foreign bank agencies could use all of the capital of the parent bank as a base for their U.S. lending. The agency would allow HSBC to lend to local clients as well as Chinese or other foreign borrowers. Deposits, on the other hand, were restricted to foreign depositors—U.S. banking law forbids agencies from taking local deposits. Many foreign banks enter the U.S. market through an initial representative office, followed by expansion into an agency. While this alternative had no major financial cost, it would limit HSBC business primarily to dealing with foreign clients.

The International Banking Act of 1978 allowed foreign banks to establish Edge Act Corporations, subsidiaries of banks that are allowed to engage only in international banking. Edge Act Corporations may not take deposits from local residents or make loans to them for domestic business, but they may take deposits from foreign residents and lend to anyone for international business. This alternative was even more restrictive than the use of an agency, so Sandberg quickly rejected it.

A wholly owned subsidiary, incorporated as a normal U.S. bank, was another possibility In this case, HSBC would need to invest enough funds in the subsidiary to start up its local lending business. Once established, the subsidiary could undertake any kind of activity allowed to domestically owned banks. This alternative would allow HSBC access to borrowing from the U.S. central bank (the Federal Reserve). The full range of borrowing and lending possibilities would be open to the new subsidiary. In order to set up a subsidiary in New York, HSBC would need to sell the California and Houston banks, since U.S. banking laws prohibited banks from owning full-service branches or subsidiaries in more than one state.

A subsidiary could be established either by creating a completely new bank with new offices and new employees, or by buying an existing bank with its existing network of offices, people, and accounts. Clearly, the second choice would be preferable, but it would cost much more. Sandberg needed to examine the expected costs of opening new offices, perhaps in New York but also possibly in San Francisco, which is closer to Hong Kong and more tied to Asian business, and where HSBC already had one subsidiary with several offices.

The use of additional representative offices was rejected immediately, since such offices would not allow HSBC direct participation in the U.S. market. Mr. Sandberg did realize, however, that it might be desirable to have representatives in several cities such as San Francisco, Chicago, Miami, and Los Angeles, in order to seek out additional business for the main office in New York. So representative offices were left as possibilities, to be considered only after the initial investment decision was made.

Finally, a joint venture with some other bank could be used. This strategy would enable HSBC to enter the U.S. market with less capital investment than the other alternatives, but it would mean sharing the decision making and the profits of the venture. A joint venture would be formed as a normal U.S. bank, similar to the subsidiary discussed above. The legal restrictions would be relatively unimportant—the key issue would be the management of the joint venture. Historically, very few joint ventures have lasted for more than a few years before the partners decided to stop the project and either operate alone or leave the market. Despite this drawback, Sandberg felt that it would be worthwhile to seek a potential partner and to compare the expected results of a joint venture with those of other alternatives.

CASE ANALYSIS

You have been appointed to a committee that is undertaking a feasibility study for the HongKong & Shanghai Banking Corporation. Mr.Michael Sandberg, chairman of the home office in HongKong, has asked your committee to study the possible ways that the bank might enter the U.S. market. He wants you to decide where to locate the HSBC offices in the United States, and which type of office will be the most profitable for the bank

Mr. Sandberg has asked you to consider the following factors :

a. The new office must be profitable for the bank.

b. It should not be too costly to establish or to maintain.

c. The office should be as free as possible from government restrictions on its operations.

To analyze the case, follow these steps :

1. Decide where to locate the new office. Give reasons for your choice.

2. Decide which type of office to establish. Consider the advantages and disadvantages of each alternative. Use the chart below to help you choose the office that best fits Sandberg’s criteria.

3. Make your recommendations to Mr. Sandberg as to where and how HSBC should enter the U.S. market. Give reasons to justify your choices. Each committee should choose a chairperson who will present the recommendations to the class. After each group has presented its analysis, the class will decide which recommendations to follow.

CRITICAL THINKING

Using the information provided in the case description, think about the following questions. Work with a partner or a small group to discuss possible approaches to the question.

1. What are some of the reasons that a foreign bank would want to get up offices in another country?

2. Discuss some of the difficulties that a foreign bank might encounter while establishing branch offices in other countries.

3. Describe the different types of offices that a foreign bank is allowed to establish abroad. Compare the advantages and disadvantages of each office.

4. If you were the manager of a foreign bank seeking to open an office in your country, where would you choose to locate the new office? Give reasons for your decision.