One Bank, Two Cultural Identities”: a Case Study of Chinese and British Influence on the financial Practices of HSBC Bank Freda C
University of Wollongong Thesis Collections University of Wollongong Thesis Collection
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”One bank, two cultural identities”: a case study of Chinese and British influence on the financial practices of HSBC bank Freda C. F Hui University of Wollongong
Hui, Freda CF, ”One bank, two cultural identities”: a case study of Chinese and British influence on the financial practices of HSBC bank, PhD thesis, School of Accounting and Finance, University of Wollongong, 2008. http://ro.uow.edu.au/theses/348
This paper is posted at Research Online. http://ro.uow.edu.au/theses/348
“One bank, two cultural identities”: a case study of Chinese and British influence on the financial practices of HSBC Bank
A thesis submitted in fulfilment of the requirements for the award of the degree:
Doctor of Philosophy
from
UNIVERSITY OF WOLLONGONG
by
Freda C.F. Hui CPA, M.Com, B.Com
School of Accounting and Finance 2008
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CERTIFICATION
I, Freda, C.F. Hui, declare that this thesis, submitted in fulfilment of the requirements for the award of Doctor of Philosophy, in the School of Accounting and Finance, University of Wollongong, is wholly my own work unless otherwise referenced or acknowledged. The document has not been submitted for qualifications at any other academic institution.
Freda Hui 18 November 2008
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ACKNOWLEDGEMENTS
I sincerely express my gratitude to my supervisors: Dr. Kathy Rudkin and the late
Dr. Hemant Deo, for their patience, helpfulness, and assistance during the course of this study. This research would not have been possible without their invaluable expertise, academic support, and belief in my work and ability. I am so grateful for the time we’ve spent together and treasure the friendship they provided.
I also wish to thank my family and friends for the support, love, and understanding they have given me throughout my studies. Special thanks to Kenneth, in Hong
Kong, for his untiring tolerance and support in completing this thesis. Thanks also to all the staff from the School of Accounting and Finance at the University of
Wollongong, and other colleagues I have met along the way, for their support and encouragement.
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ABSTRACT
After over 150 years of British rule, Hong Kong transferred its sovereignty to the
Republic of China in 1997 under the catchcry of “one country, two systems”. The most dominant bank in Hong Kong (1864-present) is the Hongkong and Shanghai
Banking Corporation (HSBC). This thesis explains the ensuing impact of the political and cultural change on the disclosures and accountability of HSBC.
HSBC’s accounting practices are not independent and self-contained. They are shaped by HSBC’s unique history and culture, and are dependent on societal expectations. Hong Kong became a British colony in 1842. The handover in 1997 brought to the fore differences in expectations and cross-cultural differences between the West and the East. Annual reports were increasingly used by the bank as a tool to legitimate HSBC with respect to societal expectations and maintain its reputation as a reliable “local” bank in Hong Kong. This study demonstrates how a bank uses financial reports politically to ensure survival and sustainability beyond the rhetoric of accountability.
The contributions of the thesis are twofold. First, it theoretically develops links between Laughlin’s (1995) Middle Range Thinking (MRT) and Institutional theory
(DiMaggio and Powell, 1983). Skeletal theory guides and facilitates the discourse necessary for analyses of political, economic, and social influences on accounting and banking. Secondly, this thesis applies methodology and methods novel to research in banking to enable a contextual understanding of the Asia Pacific regulatory environments. Both qualitative and quantitative methods of investigation
iv are employed. Because of the complexity of the situation of HSBC, an inter- subjective approach to theorising is necessary to interrogate historical and cultural impacts.
This thesis critiques the “one country, two systems” policy as it applies to the banking sector in Hong Kong. The case study of HSBC demonstrates that some significant events triggered the additional public disclosure in annual reports and public accountability in order for HSBC to legitimate itself to the new Hong Kong order and mainland China expectations. This new approach is valuable in this banking study because it gives a different perspective on acquiring banking knowledge. Blending Middle Range Thinking and Institutional theory is shown to compensate for the deficiencies in both theories.
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TABLE OF CONTENTS
Certification ...... i Acknowledgements...... ii Abstract ...... iii Table of contents...... v List of figures ...... ix Abbreviations ...... xii Chapter 1 Introduction...... 1 1. 1 The research site...... 2 1. 2 Identifying a theoretical framework for this research...... 3 1. 3 Contributions of this thesis ...... 6 1. 4 Organization of this thesis...... 6 Chapter 2 Methodological issues...... 9 2. 1 Literature review ...... 9 2. 2 Middle Range Thinking ...... 19 2.2.1 Positivist/Functionalist studies...... 22 2.2.2 Interpretive/ Relativistic studies...... 28 2.2.3 Middle Range Thinking ...... 30 2.2.4 The research approach of this thesis ...... 36 2. 3 The research site...... 40 2. 4 Data gathering for this thesis ...... 40 2. 5 Methods of data collection...... 41 2. 6 Text analysis ...... 45 2. 7 Interviews...... 49 Chapter 3 Institutional elements and HSBC...... 52 3.1 Overview of institutional theory ...... 52 3.2 The origins of institutional theory...... 53 3.3 Institutional elements ...... 56 3.3.1 Definition of ‘institutions’ ...... 57 3.3.2 Institutional isomorphism ...... 58 3.3.3 Decoupling ...... 62 3.3.4 Legitimacy ...... 63
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3.3.5 The significance of the founding of an organization ...... 64 3.4 Limitations of Institutional theory ...... 65 3.4.1 Assumption of organizational passivity...... 65 3.4.2 Lack of explanation of how institutions change ...... 67 3.4.3 Neglect of the issues of power ...... 69 3.4.4 Ignorance of the “micro” perspective ...... 72 3.4.5 Problems with decoupling...... 73 3.5 Extension of Institutional theory...... 75 Chapter 4 Historical context ...... 78 4. 1 Historical influence ...... 78 4. 2 The institutional context of early Hongkong and Shanghai Banking Corporation ...... 79 4. 3 Birth of HSBC...... 85 4.3.1 Founder’s influence – internal pressure ...... 89 4.3.2 Early financial reporting of HSBC...... 91 4. 4 External pressure...... 101 4.4.1 Criticisms of the financial arrangement of the HSBC ...... 102 4. 5 Expansion of the bank...... 112 4. 6 Banking sector in Hong Kong...... 118 4.6.1 Importance of HSBC in the history of the currency system in Hong Kong 122 4.6.2 HSBC as the de facto central bank of Hong Kong ...... 126 4.6.3 Political influence of HSBC...... 128 4. 7 HSBC and the transition of Hong Kong ...... 138 4.7.1 De facto central bank status change...... 148 4.7.2 Rise of the Bank of China (BOC) ...... 149 4.7.3 Note-issuing ...... 150 4.7.4 Political aspects...... 151 4. 8 One country, two systems ...... 153 4.8.1 Two monetary systems...... 153 4.8.2 Two monetary authorities – HKMA vs PBC ...... 153 4.8.3 Two currencies – HK$ vs RMB...... 154 4.8.4 Two professional accounting bodies...... 154
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4. 9 Accounting developments in Hong Kong...... 156 4. 10 Players around the organization...... 157 4.10.1 Companies Ordinance in Hong Kong ...... 158 4.10.2 Accounting Professional body in Hong Kong ...... 161 4.10.3 The Exchange Banks’ Association (EBA)...... 166 4.10.4 Hong Kong Association of Banks (HKAB)...... 167 4.10.5 Bank Ordinance/Legislation...... 168 4.10.6 Stock Exchange requirements...... 171 Chapter 5 Accounting in HSBC 1967-1979 ...... 177 5. 1 Accounting as an institutional element ...... 178 5. 2 Disturbances...... 180 5.2.1 Disturbances before 1967 – acquisition of Hang Seng Bank...... 180 5.2.2 Devaluation of Sterling in 1967 ...... 184 5.2.3 Acquisition of Marine Midland Banks Incorporated (MMBI) ...... 187 5. 3 Annual reports of HSBC 1967-1979...... 189 5.3.1 Notes on accounts ...... 191 5.3.2 Inner reserves issues (1967-1979)...... 192 5.3.3 Revaluation of property and investments in subsidiaries...... 195 5.3.4 Audit Report 1967-1979: ...... 197 5.3.5 Other disclosure issues...... 199 5. 4 Capital requirement (Capital/asset ratio) 1967-1979 ...... 201 5. 5 Role of de facto central bank and accounting procedure for the acquisition of Marine Midland Bank (MMBI) ...... 202 Chapter 6 Accounting in HSBC 1980-1996 ...... 207 6. 1 Disturbances during the 1980s...... 208 6.1.1 Banking crisis...... 208 6.1.2 The restructure of HSBC...... 210 6.1.3 Hong Kong “1997 issue” ...... 226 6.1.4 HSBC realigning itself with China in the 1980s...... 230 6.1.5 Stock market crash in 1987...... 235 6.1.6 1988 New accounting arrangements ...... 236 6.1.7 Move to London...... 239 6. 2 Accounting issues ...... 245
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6.2.1 Provision for bad doubtful debts account ...... 245 6.2.2 Capital/assets problem- 1980 ...... 248 6.2.3 Capital adequacy ratio...... 252 6.2.4 Changes in accounting methods...... 255 6.2.5 Off-balance sheet items...... 257 6.2.6 Taxation issues...... 259 6.2.7 Disclosure of the inner reserve...... 260 6.2.8 Political issues...... 266 6. 3 Three years before the handover...... 268 6.3.1 Additional summary of financial performance ...... 270 6.3.2 Influence of the Chinese culture ...... 270 6.3.3 Change of accounting standards in Hong Kong...... 273 Chapter 7 Accounting in HSBC 1997 – 2004 ...... 278 7. 1 Asian financial crisis 1997-1999...... 279 7. 2 Performance ratios ...... 281 7.2.1 Capital adequacy ratio...... 281 7.2.2 Liquidity ratio...... 286 7.2.3 Return on average shareholders’ funds...... 287 7.2.4 Net interest margin...... 290 7. 3 Advances to customers...... 292 7. 4 Related party transactions ...... 300 7. 5 Pictorial content in HSBC annual reports ...... 301 7. 6 Structural change...... 306 Chapter 8 Conclusion ...... 310 8. 1 From the perspective of institutional theory ...... 313 8. 2 Contributions...... 321 8. 3 Limitations and recommendations for future research in the area...... 322 References...... 324 Appendix 1 Transcripts of Unstructured interviews ...... 348 Appendix 2 Summaries of the development of accounting in Hong Kong ...... 352 Appendix 3 Notes on Accounts ...... 353 Appendix 4 Financial statements of HSBC ...... 356
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LIST OF FIGURES
Figure 2-1 Cartography of Middle Thinking adopted from Burrell and Morgan (1979) ...... 20 Figure 2-2 Dimensions on the choice process for empirical research from Laughlin, 1995, p.68...... 22 Figure 2-3 Alternative research approach assumptions adopted from Laughlin (1995, 2004) ...... 35 Figure 2-4 Institutional theory as the skeleton theory...... 38 Figure 2-5 Overview of institutional theory as the theoretical lens...... 38 Figure 2-6 Summary of the research approach and the middle range position...... 39 Figure 2-7 Summary of data used in this research...... 44 Figure 4-1 Institutional view of the internal and external pressure on the bank...... 79 Figure 4-2 View of Hong Kong , George Chinnery (1852)...... 81 Figure 4-3 Treaty of Nanking (1842)...... 82 Figure 4-4 Logo of Hongkong and Shanghai Bank Corporation 1865 – 1982...... 88 Figure 4-5 An institutional view of the historical context of early HSBC...... 89 Figure 4-6 The first annual report of HSBC in 1865 ...... 95 Figure 4-7 China Punch New Year’s cartoon...... 106 Figure 4-8 Abstract of Assets and liabilities and Profit and Loss 1867 - 1874 ...... 108 Figure 4-9 An advertisement in 1959 announcing Hongkong and Shanghai Banking Corporation’s acquisition of Mercantile Bank Ltd and The British Bank of the Middle East ...... 115 Figure 4-10 Number of representatives in the Executive/Legislative Council of Hong Kong (1967-2005)...... 133 Figure 4-11 Distribution of Execo members...... 134 Figure 4-12 Distribution of Legco members...... 134 Figure 4-13 Sir Thomas Jackson statue ...... 136 Figure 4-14 Name of representatives of HSBC in Executive/Legislative Council (1967-1996)...... 137 Figure 4-15 Buildings of HSBC and BOC in Hong Kong...... 143 Figure 4-16 Logo of HSBC 1983-present...... 146
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Figure 4-17 Accounting development in Hong Kong time-line ...... 160 Figure 5-1 Summary of disturbances ...... 180 Figure 5-2 Liquidity Ratio 1967-1979...... 184 Figure 5-3 Total number of pages in annual report 1967-1979 ...... 190 Figure 5-4 Capital/Assets Ratio 1967-1979...... 204 Figure 6-1 1HSBC Annual Report 1980 – “The Pearl of the Orient with the Big Apple”, 3 ...... 212 Figure 6-2 HSBC Annual Report 1980 cover...... 212 Figure 6-3 Hongkong Bank logo in 1982 ...... 213 Figure 6-4 Cover of 1982 annual report...... 215 Figure 6-5 First building of HSBC and new Treasure ...... 217 Figure 6-6 Symbols of security on firemarks and HSBC’s hexagon symbol...... 217 Figure 6-7 Total number of pages in annual report 1980-1996 ...... 219 Figure 6-8 The bronze lion statue outside the HSBC building...... 222 Figure 6-9 Drawing in South China Morning Post 1984...... 222 Figure 6-10 Hongkong and Shanghai Banking Corporation one dollar note in1872...... 223 Figure 6-11 Hongkong and Shanghai Banking Corporation ten dollar bank note in 1982...... 224 Figure 6-12 Hongkong Bank ten dollar banknote 1990...... 224 Figure 6-13 HSBC twenty dollar banknote 1994...... 225 Figure 6-14 HSBC twenty dollar banknote 2003...... 226 Figure 6-15 1984 Annual report cover...... 229 Figure 6-16 Number of Board of Directors 1967-2004 ...... 234 Figure 6-17 Accounting arrangement in Hong Kong ...... 238 Figure 6-18 Capital to assets ratio 1980-1996 ...... 252 Figure 6-19 Capital/risk-weighted assets 1999-1996...... 255 Figure 7-1 Capital adequacy ratio for HSBC for 1989 -2004...... 285 Figure 7-2 Liquidity ratio 1997-2004 ...... 287 Figure 7-3 Return on average shareholders’ funds ...... 290 Figure 7-4 Comparison of net interest margin 1997-2004...... 291 Figure 7-5 Other Operating Income 1998 - 2004 ...... 291
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Figure 7-6 Advances to customer according to HSBC (abstract from HSBC Annual Report 2004, p.32) ...... 293 Figure 7-7 Advances to customers according to HKMA (abstract from HSBC Annual Report, 1997, p.33)...... 294 Figure 7-8 Comparison of Advances to Customers 1997-2004...... 299 Figure 7-9 HSBC Annual Report 1997-2000 ...... 304 Figure 7-10 HSBC Annual Report 2000-20044 ...... 305 Figure 8-1 Summary of findings...... 316
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ABBREVIATIONS
ASC Accounting Society of China Hongkong Bank The Hongkong and Shanghai Banking Corporation BMA British Monetary Authority BOC Bank of China BOCI Bank of China International Holding Ltd CICPA Chinese Institute of Certified Public Accountants DEA Data envelopment analysis DTC Deposit Taking Companies EBA The Exchange Bank Association Execo Executive Council FTSE London Stock Exchange GAAP General Accepted Accounting Principles HK Hong Kong HKAB The Hong Kong Association of Banks HKFRs Hong Kong Financial Reporting Standards HKICPA Hong Kong Institute of Certified Public Accountants HKMA Hong Kong Monetary Authority HKSA Hong Kong Society of Accountants HKSE Hong Kong Stock Exchange HSBC The Hongkong and Shanghai Banking Corporation HSI Hang Seng Index IASB Institutional Accounting Standards Board ICD Intellectual capital disclosure Legco Legislative Council MMBI Marine Midland Bank Incorporated MOF Ministry of Finance NPL Non-performing loan NYSE New York Stock Exchange PBC People’s Bank of China
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PRC People’s Republic of China RMB Renminbi SAR Special Administrative Region SEC Securities Exchange Commission SEHK The Stock Exchange of Hong Kong SSAP Statement of Standard Accounting Practices WTO World Trade Organization
Chapter 1 Introduction 1
CHAPTER 1 INTRODUCTION
After over 150 years of British rule, Hong Kong’s sovereignty was transferred to the
Republic of China in 1997 under the catchcry of “one country, two systems”. Hong
Kong was a British Colony from 1842 until 1997. The Basic Law of Hong Kong and the Sino-British Joint Declaration signed in 1984 stipulate that Hong Kong operate with a high degree of autonomy for 50 years after the transfer. Under this policy of ‘one country, two systems’, Hong Kong has its own monetary system, and legal system. These systems are mostly ‘inherited’ from the British. At the same time, it has to comply with the Chinese rules. The most dominant bank in Hong
Kong (1864 – present) is the Hongkong and Shanghai Banking Corporation
(HSBC). This thesis explains the ensuing impact of the political and cultural change on the disclosures and accountability of HSBC. The main purpose of this study is to explore changes in the annual reports of HSBC in Hong Kong in response to the changed external environmental conditions. Thus, the research question considered in this thesis is “Do the political and cultural changes materially alter the disclosures practices of HSBC, and if so, do they demonstrate more accountability to both shareholders and the public interest?”
This thesis studies the impact of the Chinese resumption of Hong Kong on HSBC’s disclosure and financial reporting practices before and after the 1997 handover.
In this introductory chapter for the study of annual reports of HSBC, section 1. 1 will discuss the research site, including the historical context and its significance for this study, followed by a discussion of the theoretical framework and the skeleton
Chapter 1 Introduction 2 theory used in this study in section 1. 2. The organization of the thesis will be detailed in section 1. 4.
1. 1 The research site
Hongkong and Shanghai Banking Corporation (HSBC)’s annual reports (limited to the Hong Kong’s cooperation and not the whole group) are the focus of this thesis.
HSBC is a unique organization, with its own distinct history and culture, developed over the last 144 years, since its founding in Hong Kong in 1864. HSBC was established by Scotsman Thomas Sutherland, who influenced the bank’s operation with Scottish banking principles. The bank was a then de facto central bank in Hong
Kong before the Hong Kong Monetary Authority (HKMA) was set up in 1993. It is a multinational ‘local’ bank and note-issuing bank in Hong Kong. In 2008, the bank has over 10,000 offices in 83 countries, 330,000 staff and 128 million customers worldwide (HSBC, 2008). It is named the world’s most valuable banking brand by
The Banker magazine and is the world’s largest banking group in terms of market value and most profitable bank in the world according to the Forbes list in 2008 (The
Banker, 2008). HSBC headquarters is located in London and it is a public limited company incorporated in England. HSBC Holdings was established in 1991 in response to the change of domicile occurring with the transfer of Hong Kong’s sovereignty. However, it is still the most dominant bank in Hong Kong; for example, it has printed most of Hong Kong’s currency in its own name since 1997.
Changes experienced by the bank over the years have emanated from both internal and external sources. Although HSBC was founded by the English and Scottish, and accounting practices were mostly influenced by the West, Chinese culture has
Chapter 1 Introduction 3 been embedded in the bank. From an internal perspective, there have been a number of factors which have had a significant impact on the annual reports, such as the
Scottish principles. External pressures included the establishment of HKMA (which replaced its role as the de facto central bank in Hong Kong), the change from British rule to Chinese rule in 1997, the changing legislative and professional requirements for accounting and accountability, changing banking regulations and requirements, and community expectations. These changes have been overlaid on a unique culture which has emanated from the bank’s origins and subsequent development.
Accounting has played a significant role in HSBC. All of the above changes have had great impacts on its annual reports. These influences will be explored in more detail in chapters six and seven.
HSBC was selected for this thesis because its business life, beginning in the 1860s and continuing until now, covers a period of transition from the time it was run under British colonial rule to the present when it is run under Chinese rule. Annual reports of the bank from 1967 reflect this change of emphasis and transition from
Western to Eastern rule.
1. 2 Identifying a theoretical framework for this research
HSBC’s accounting practices are not independent and self-contained. They are shaped by HSBC’s unique history and culture, and are dependent on societal expectations. The handover in 1997 brought to the fore differences in expectations and cross-cultural differences between the West and the East. Annual reports were increasingly used by the bank as a tool to legitimate HSBC with respect to societal expectations and maintain its reputation as a reliable “local” bank in Hong Kong.
Chapter 1 Introduction 4
This study demonstrates how a bank uses financial reports politically to ensure survival and sustainability beyond the rhetoric of accountability.
This thesis applies novel methodology in banking literature and understanding of the
Asia Pacific regulatory environment. Research on accounting in banking contexts traditionally supported the use of positivist approaches as a research methodology
(Chua, 1986a, 359). The positivist research methodology ontologically assumes that an objective reality exists and epistemologically assumes the independence of both the observer and the observed. Methods used in this approach are mainly quantitative. On the other hand, the interpretive approach ontologically assumes that social reality does not exist independently of the participants who construct it
(Chua, 1986a, Covaleski and Dirsmith, 1990, Morgan, 1980) and epistemologically assumes the discovery of knowledge and reality rely on the observer’s subjective observation. Methods used in this approach are therefore heavily descriptive.
Because of the complexity of the research site, inter-subjective understanding of theory is important. Laughlin’s Middle Range Thinking (MRT) (Laughlin, 1995,
2004) allows the researcher to illustrate both quantitative and qualitative information and provide a richer understanding of the research site than it would if based solely on positivist or interpretive approaches alone. Both qualitative and quantitative methods of investigation are employed in this case study. The methodology is based on the framework of Laughlin’s Middle Range Thinking (Laughlin, 1995, 2004) applied to accounting in banking contexts research which can accommodate alternative methodologies. Institutional theory is used as the skeletal theory to guide and facilitate the discourse necessary for analysis of the political, economic, and
Chapter 1 Introduction 5 social influences on accounting disclosures of HSBC. Organizations are generally assumed to resist change by the external environment. Laughlin (1991) suggests that these external environmental disturbances cause organizations to adapt, reorient, and transform in response to the changed external environment and at the same time attain a balanced state of the organizational elements.
This thesis theoretically develops links between MRT and institutional theory. Text analysis and unstructured interviews are used in this study to analyse the history, performance, organizational structure and use of symbolism by the bank.
Institutional theory (DiMaggio and Powell, 1983) identifies the factors that influence organizations and helps to explain why organizations have to behave in certain ways because of different expectations and pressures. These expectations are embedded in society and organizations. Organizations can achieve and maintain legitimacy for survival if they can fulfil these expectations. Therefore, it has the capability of considering the organizational and social context of accounting practice by emphasizing the influence of the institutions both of society and the organization.
The analysis of the data pertaining to changes in HSBC’s annual reports was carried out using the theoretical underpinnings of institutional theory.
The changes in political and societal expectations after 1997 have placed great pressures on organizations such as HSBC. This theory helps both to investigate and explain the long-term survival of the bank. This will be explored fully in Chapter three.
Chapter 1 Introduction 6
1. 3 Contributions of this thesis
Organizations have to adjust or adapt according to changing circumstances to ensure their long-term survival and sustainability. HSBC also has to adjust its disclosures and accountability in its annual reports in response to the impact of the political and cultural changes in Hong Kong. The contributions of this thesis are twofold. First, it theoretically develops links between Laughlin’s (1995, 2001) Middle Range
Thinking and Institutional theory (DiMaggio and Powell, 1983). Skeletal theory guides and facilitates the discourse necessary for analyses of the political, economic, and social influences on accounting and banking. Secondly, this thesis applies methodology and methods novel to research in banking to enable a contextual understanding of the Asia Pacific regulatory environments.
1. 4 Organization of this thesis
This thesis comprises eight chapters. This section outlines the remaining seven chapters. Chapter two presents a literature review on banking and accounting research. The methodological issues in banking research are reviewed and developed to accommodate the specific requirements of this research. Laughlin’s
Middle Range Thinking, which is used to conduct this thesis, will be described in detail.
Chapter three explains in more detail the institutional lens through which the annual reports of HSBC are viewed. It details the development of Institutional theory, its limitations and relevance to this research.
Chapter 1 Introduction 7
Chapter four explores the historical and contextual impacts of the case study. These include the historical influences of the bank’s founders, external pressures, political issues, and the development of the bank.
Chapters five to seven are the empirical chapters of the thesis. These three chapters divide the period of HSBC’s annual reports into three distinct phrases. Chapter five presents the period 1967 – 1979 of HSBC, which covers the period when external disturbances of an economic, societal and cultural nature were emerging. These changes had an influence on the annual reports of HSBC. The chapter discusses changes in the annual reports and how the bank was influenced by political factors.
Chapter six presents the period 1980 – 1996. This part of the thesis will discuss the disturbances caused by the initial negotiation for the handover of Hong Kong back to China, the restructure of the bank, and the establishment of HKMA. This chapter discusses changes in the annual reports during the transition period.
Chapter seven presents the period 1997 – 2004. It discusses the period after Hong
Kong’s sovereignty was transferred to China. This chapter discusses the disturbances caused by the Asian financial crisis in 1997, and some specific changes in the financial disclosures of HSBC in response to the external disturbances.
These three chapters build a basis for chapter eight, which concludes the analysis using both Middle Range Thinking and Institutional theory. Chapter eight, building upon the previous chapters, concludes the thesis. This chapter discusses the conclusions drawn from the research question, limitations of the study, its
Chapter 1 Introduction 8 contributions and the significance of this research. Finally, the chapter concludes the thesis by giving indications for future research on related issues.
HSBC incorporates institutional practices in order to gain and/or maintain legitimacy, and hence survival. It is devoted not only to technical performance, but also to conforming with established institutional practices. The financial reporting and disclosures of HSBC’s annual reports are constantly evolving because of
HSBC’s own embedded institutional practices, interactions and responses to external disturbances in its environment. This thesis focuses on HSBC’s responses to institutional pressures by observing the way it constructs its own identities through its use of annual reports. This thesis will answer the research question “Do political and cultural changes materially alter the disclosures practices of HSBC, and if so, do they demonstrate more accountability to both shareholders and the public interest?”
This thesis will make a unique contribution particularly to the existing literature in the areas of Laughlin’s Middle Range Thinking (Laughlin, 1995, 2004) and
Institutional theory, and accounting as used in a banking context. This thesis also provides an opportunity to observe the impact of annual reports at a time of significant historical change.
Chapter 2 Methodological Issues 9
CHAPTER 2 METHODOLOGICAL ISSUES
Chapter one provided an introduction to this study. It also represented the outline of the thesis and established the research question. This chapter will explore the methodological issues of the thesis. Section 2. 1 is a literature review on the previous studies of the banking sector in Hong Kong. In Section 2. 2, the theoretical lens of Laughlin’s Middle Range Thinking (1995, 2004) is used to discuss the differences, in terms of ontological, epistemological, and methodological assumptions, between the mainstream/positivist approaches and an interpretivist approach to accounting studies. Middle range thinking is the approach adopted in this thesis. Section 2. 3 discusses the research site of this research. Section 2. 4 discusses the distinction between methodology and methods as applied in this thesis. Section 2. 5 explains the methods chosen to conduct this case study of HSBC. Section 2. 6 discusses detail in text analysis as applied in this study, followed by a discussion of the issues of interviewing as a method in section
2. 7.
2. 1 Literature review
By the end of 2006, there were 138 licensed banks1 and 31 restricted-licence banks2 and 33 deposit-taking companies3 within the three-tier banking system in
Hong Kong (Hong Kong Monetary Authority, 2008). Hong Kong has one of the
1 Licensed banks may operate current and savings accounts, and accept deposits of any size and maturity from the public and pay or collect cheques drawn by or paid in by customers in Hong Kong. 2 Restricted-licence banks engage in merchant banking and capital market activities. They may take deposits of any maturity of HK$500,000 and above. 3 Deposit-taking companies engage in a range of specialised activities, including consumer finance and securities business. They may take deposits of HK$100,000 or above with an original term of maturity of at least three months.
Chapter 2 Methodological Issues 10 largest representations of international banks in the world, with 71 of the world’s
100 largest banks having a presence (Hong Kong Special Administration Region,
2005). Among all the financial institutions, 121 were foreign-owned and only one restricted-licence bank and 11 deposit-taking companies were locally owned.
Hong Kong is also the world’s ninth largest international banking centre in terms of the volume of external transactions and the third largest in Asia in 2007 (Hong
Kong Trade Development Council, 2007). HSBC is among the largest banking and financial services organizations in the world with over 10,000 branches and offices in 83 countries (HSBC, 2008). This context justifies HSBC as a significant organization worthy of this in-depth study.
Traditionally, much research in the banking literature incorporated analysis using a positivist methodology (Searcy and Mentzer, 2003). Studies such as Hempel
(1999), Weaver (2001), Rose (2002) and De Lucia and Peters (2003) mapped out measures using quantitative methods to attain certain goals and objectives, and explored aspects of profit generation. For example, they used performance evaluation measures based on profit by using risk-adjusted return on capital4 to evaluate loans and using the economic value added5 method. However, none of these studies explain the social and cultural perspective of the banking industry.
Ang and Cummings (1997) have undertaken an empirical research to examine banks’ strategic responses to institutional influences on information systems
4 Risk-adjusted return on capital (RAROC) allows the estimation of required loan prices with interest charges to ensure loans are profitable. 5 Economic value added (EVA) is a measure of the value added by the bank’s operations over the cost of capital used. It includes the operating profit after tax available to ordinary shareholders.
Chapter 2 Methodological Issues 11 outsourcing in light of hypercompetition6. They find that different types of institutional influence evoked different strategic responses from the bank. They also find that large banks temper their strategic responses more than small banks.
Their findings were consistent with Oliver’s (1991) argument that organizations need not passively conform to institutional influences.
Banking sector in Hong Kong
As part of this literature, case studies have also been done based on the Hong Kong economy, specifically banking aspects of Hong Kong. However, to date there has not been a specific case study done on HSBC. For example, Jao (1971) analysed the growth of and structural change in the commercial banking industry, and evaluated the contribution to the economic growth in Hong Kong during 1954-
1968. However, he did not explain the reasons from the social perspective and the power influence of the British and the Chinese Governments.
Lau (1985) studied the prospects of Hong Kong as an international banking centre by interviewing authoritative personnel of international banks in Hong Kong. He also relied heavily on statistical results to draw the conclusion that the future of
Hong Kong relied on political change, the economic development of China and the growth of Asian countries. This study explored the banking sector in Hong Kong.
However, this study did not consider the internal attributes of the banks themselves.
6 Hypercompetition refers to the “rapidly escalating competition based on new and continually shifting product or geographic markets, frequent entry of unexpected competitors, radical redefinition of market boundaries, rapidly changing technologies, and short product life cycles” (Ang and Cummings, 1997, 236).
Chapter 2 Methodological Issues 12
Wong and Birnbaum-More (1994) used empirical analysis to examine the context of society and culture as predictors of organizational structure in 39 multinational banks operating in Hong Kong between 1981 and 1984. They used Aston instruments to operate using the organizational structure and context, and
Hofstede’s measures of power distance to operationalize culture. Their results suggested that the competitive requirements of the Hong Kong environment placed a premium on efficiency and flexibility in responding to market demands.
Subsidiaries of multinational banks operating in Hong Kong responded structurally to the requirements of their competitive environment rather than to their parent organization’s demands for accountability. Their studies inform this study as they concluded that banks in Hong Kong were under a coercive influence from the environment.
Hong (1997b) has conducted an analysis of the feasibility of establishing a mortgage corporation in Hong Kong to securitize mortgages, as recommended by the Hong Kong Monetary Authority (HKMA) in 1995. She used a qualitative approach with reference to quantitative analysis performed by the HKMA and market resources. She concluded that the benefits of the mortgage corporation could be marginal in the short term and might be outweighed by the costs.
However, she also commented that it was inevitable that HSMA would establish the mortgage corporation after1997.
Chapter 2 Methodological Issues 13
Wai (1999) did a cross-sector case study of Hong Kong by applying embedded autonomy7 to the banking, textiles and garments, and electronics sectors to explain economic performance in Hong Kong. Primary fieldwork and surveys were used to find out the general attitude among industrial actors towards the government’s performance on embedded autonomy parameters such as corporate coherence and state-society connectedness. She concluded that embedded autonomy is found to be high in the banking sectors compared with the other two sectors.
Tong et al., (2002) conducted surveys of 76 loan officers from banks about the usefulness of general purpose financial statements for making lending decisions in
Hong Kong. They concluded that the current framework for financial reporting and auditing in Hong Kong did not provide adequate information for decision making on lending issues. There were expectations gaps in financial reporting from the perspective of the banks’ loan officers. Their findings raise the issue of deficiency in financial reporting and auditing in Hong Kong.
Tse and Yip (2003), examined empirically the effectiveness and impacts of monetary reforms8 in Hong Kong since the late 1980s. Their results showed that
HSBC was able to exploit its position as a clearing bank (refer to Section 4.6.2) by creating money without an appropriate increase in the US dollar backup. They
7 Peter Evan has done comparative research on the successes and failures of state involvement in the process of industrialization. He concluded that a successful state requires an understanding of its limits, relationship to the global economy and the combination of internal organization and close links to the society, which was labelled by him as “embedded autonomy” (Evan, 1995, Embedded Autonomy: States and Industrial Transformation, Preston University Press). 8 These monetary reforms included the accounting arrangements (these will be discussed in chapter 6), liquidity adjustment facility, and the revised mode of monetary operations.
Chapter 2 Methodological Issues 14 inferred that HSBC’s special position during the pre-accounting-arrangements period (see Section 4.6.2) led to a higher volatility in Hong Kong’s interbank rates.
Lim and Randhawa (2005) used data envelopment analysis (DEA)9 to access the
X-efficiency of banks in Hong Kong and Singapore via a two-stage banking model.
They used DEA to measure the efficiencies of two different functions performed by banks in Hong Kong and Singapore. They also compared the relative efficiency of banks in the two markets. They found that there is a statistically significant relationship between bank size and the X-efficiency.
Gerlach and Peng (2005) studied the relationship between residential property prices and bank lending in Hong Kong by using the error-correction model10. They concluded that there was a strong correlation between credit growth and bank lending, which was due to bank lending adjusting to property prices rather than the converse. Their results also showed that property prices determine bank lending but not vice versa. The change in regulation to tighten credit standards in the early
1990s played an important role. Prudential regulation and risk controls by banks limited the exposure of the banking sector to swings in property prices. Therefore, the banking system remained sound despite the property bubble bursting between
1997 and 2005.
9 DEA is a mathematical programming approach and a nonparametric method in operations research and economics for the estimation of production frontiers. It is a linear programming methodology to measure the efficiency of multiple decision-making units Seiford, L. M. & Thrall, R. M. 1990. Recent developments in DEA: The mathematical programming approach to frontier analysis Journal of Econometrics, 46: 7-38.. 10 An error-correction model is a dynamic model in which "the movement of the variables in any periods is related to the previous period's gap from long-run equilibrium” (http://economics.about.com/library/glossary/bldef-error-correction-model.htm).
Chapter 2 Methodological Issues 15
Drake et al. (2006) assessed the relative technical efficiency of institutions in the
Hong Kong banking system. This study uses both the slacks-based model (SBM),
Banker, Charners and Cooper (BCC) approaches, and profit-based DEA. They analysed the impact of environmental factors on the efficiency of Hong Kong’s banking system utilizing a “profit approach” specification. The result suggested that banks in Hong Kong have been affected by a range of external factors
(macroeconomic and housing market factors) outside the control of institutions’ management. They concluded that the accession of Hong Kong to China and the
Asian Financial crises chronologically did not seem to have had a significant independent impact on relative efficiency. Different-sized banks and different institutional sectors had been differentially affected.
The above studies demonstrate an analysis from mainstream approaches, predominately using quantitative methods, which will be critiqued in section 2.2.1.
In such research, reality or ‘what is’ is assumed to pre-exist independent of thought, language and social practices (Chua, 1986a, Dillard, 1991, Watts, 1995).
From the above studies, we know a lot about the profitability and efficiency of the banking industry in Hong Kong by using quantitative analysis but nothing about the culture and political influences on HSBC. Although profit is important to explain an organization’s growth and survival, social factors such as political influences, culture and power struggles are important components in the operation of banks. Such factors have not been incorporated into the research questions of the studies described above. These components cannot be completely explained by quantitative methods located in a positivist paradigm (Burrell and Morgan, 1979).
Chapter 2 Methodological Issues 16
Cultural context of Hong Kong
Hong Kong was regarded as a highly collectivist culture by Hofstede (1980). He identified it as very different from the individualism of Western societies. The business environment in Hong Kong is quite unique compared to other countries in
Asia because it had been a British colony since 1845. Most organizations originated as family-owned companies in Chinese society, including the banking industry. Although HSBC was established as a Hong Kong bank following
Scottish banking principles and governed by British management, the Chinese culture has been embedded in the bank. The British influence can be explained as an environmental disturbance (Laughlin, 1991). Hong Kong Chinese society reflected Confucianism; however, these values may have weakened in Hong Kong
(Hong, 1997a, Taornina and Bauer, 2000) as Chinese in Hong Kong were exposed to the multicultural difference of British rule since 1845. This is further discussed in section 4. 1.
Lowe (1998, 324) commented that Hong Kong was an Anglo-Saxon country and “a reflection of the Western focus of both Marx and Weber, constitut[ing] a Western political continuum founded upon Western philosophy and history”. Tse et al.,
(1988) and Wilkinson (1996) also argued that Chinese executives from Hong Kong were influenced by a combination of Western and Chinese cultural norms rather than by their Chinese heritage.
Ko and Lee (2000) applied the strategy formulation framework (a combination of
SWOT analysis and the balance scorecard) with quality function deployment methodology, which is geared for an Asian culture within the banking industry of
Chapter 2 Methodological Issues 17
Hong Kong. They concluded that this framework allowed intercultural adaptations for most organizations since Hong Kong was a unique place with both Eastern and
Western cultures.
Accounting plays an important role in the banking operations and is “intertwined with organizational functioning” (Hopwood, 1983, 287). It is also socially constructing and socially constructed (Chua, 1986a, Chua, 1986b, Hines, 1988).
The results achieved by positivist (also know as mainstream or functionalist research) only reflect social, cultural, historical or political aspects in a generalized way. The uniqueness of the organization itself and its social actors, and its relationship with its environmental context, cannot be fully explained using such methods. It also “cannot maintain [a] reflective view outside the current system” from the functionalist perspective (Dillard, 1991, 24). This is especially the case in a large organization such as HSBC because financial reports only reflect the profitability of the bank but cannot show the true picture of the bank’s influence on society and its political influence.
The ontological assumption of realism claimed by mainstream approaches and the importance of interpretive factors has been questioned by a number of researchers
(Arrington and Francis, 1993, Burchell et al., 1980, Burchell et al., 1985, Chua,
1986a, Hines, 1989, Hopwood, 1983, Tomkins and Groves, 1983). The methods used in the mainstream investigation process are also limited to quantitative questions. It constrains the types of questions that a researcher can ask and the range of answers. The contribution of this thesis is to utilize alternatives to positivist approaches in research in the banking discipline, in order to gain a
Chapter 2 Methodological Issues 18 comprehensive understanding beyond previous studies. Burchell et al., (1980) suggested that social factors should be recognized and included in social research.
Irvine (1999) used the Institutional theory to tackle such social research problems.
This thesis investigates cultural influence on the banking and accounting of HSBC, and the impact of political change on financial reports in the banking sector using
HSBC. Therefore, there is a need to use alternative approaches to capture the non- generalizable social factors that are omitted in mainstream research, to provide a richer picture. Different methods of investigation which incorporate social and environmental factors can also be used in other approaches. According to Dillard
(1991, 18), critical social science “provides ground for questioning the dominant functionalist view of investigation, understanding and value”. This thesis argues that it is important that researchers interconnect or interrelate with the environments within the overall banking system, to view the complex functions of social factors and the environment described.
Only a limited amount of research has been done on accounting in banking from the alternative approaches, especially the banking sector in Hong Kong. For example, Chan (1998) examines the banking relationship between Hong Kong and
Mainland China after 1997, and Chan (2002) analysed the power relations among interest groups behind the regulation of banking in Hong Kong. These studies encompassed cultural change and power struggles in Hong Kong. The contribution of this thesis is to argue that political and economic factors are important components in explaining financial accounting disclosures in the operation of the bank, HSBC, and the author of this thesis has no knowledge of any study that has
Chapter 2 Methodological Issues 19 taken these factors into account in the banking sector of Hong Kong, and specifically in examining one influential organization.
2. 2 Middle Range Thinking
This thesis uniquely adapts the approach of Middle Range Thinking developed by
Laughlin for a case study in the banking sector. Laughlin (1995, 2004) proposed middle range thinking to understand social systems. The Middle Range Thinking framework can be said to be consistent with the development of Burrell and
Morgan’s (1979) paradigms for the analysis of social theory (refer to Figure 2-1).
Burrell and Morgan’s sociological framework provides a way of looking at the environment using the assumptions of four paradigms: radical humanist, radical structuralist, functionalist and interpretive. It helps identify and classify the underlying assumptions about the nature of social science, which includes the accounting and banking disciplines.
Chapter 2 Methodological Issues 20
Figure 2-1 Cartography of Middle Thinking adopted from Burrell and Morgan (1979)
Sociology of Radical change
Radical Radical Humanist Structuralist
Middle Subjective Objective Range Thinking
Interpretive Functionalist
Sociology of Regulation
The methodologies I use in this case study straddle two of Burrell and Morgan’s four quadrants, being the radical humanist quadrant and interpretive quadrant (refer to Figure 2-2). If I took Burrell and Morgan’s framework, I would be stuck in one paradigm, not allowing me to use other methods. However, Middle Range
Thinking says that different paradigms have different merits for different jobs. By allowing a tolerance for different ontological positions, a cross-section of different views of interpretations is possible. However, as argued by Burrell and Morgan, these quadrants are “contiguous but separate” (1979, 22). Alvesson and Deetz
(2000) identify as a limitation of Burrell and Morgan’s four distinct paradigms that
Chapter 2 Methodological Issues 21 they do not allow for a cross-paradigm view to describe different approaches to organization science. Deetz (1996) described it as “incommensurability of paradigm”. Each paradigm shares some functions with its neighbour paradigm in one dimension and at the same time differs from it in the other dimension. Each paradigm generates different concepts and analytical tools. Therefore, Laughlin developed Middle Range Thinking as a methodology to capture the potential knowledge development of each paradigm.
Laughlin (1995, 2004) developed a three-dimensional plane (theory choice, methodological choice and change choice) that addresses the nature of methods and methodology for empirical research (for example, Broadbent and Laughlin (1998),
Broadbent et al. (1993), and Laughlin (1991)). It is named Middle Range Thinking because it takes the middle of the three continuums (dimensional plane) (Figure
2-1). His model does not impose strict boundaries and offers more positions with which to align one’s work. It can accommodate alternative methodologies and skeletal theory to facilitate the discourse necessary for analysis (Kaidonis, 1996).
Laughlin (1991) suggested that developing analysis and understanding in social settings requires theory to be located in empirical and contextual information. The theoretical ‘skeleton’ must be accompanied by the empirical ‘flesh’.
Chapter 2 Methodological Issues 22
Figure 2-2 Dimensions on the choice process for empirical research from Laughlin,
1995, p.68
One dimension is a subjective and objective continuum, as used in Burrell and
Morgan’s (1979) framework. The ontological, epistemological and methodological assumptions were consistently aligned with the positivist/functionalist ontology, positive approach, and radical structuralist in one end of Laughlin’s (1995) continuum. The other end of the continuum was consistent with the interpretivist ontology and interpretive approach. Middle Range Thinking is in between the two.
This thesis is working between these two of the four quadrants. An overview of the positivist approach will be discussed in section 2.2.1, interpretivist approach in section 2.3.2, and middle range positions and assumptions in section 2.2.3.
2.2.1 Positivist/Functionalist studies
One end of Laughlin’s (1995, 2004) continuum is positivism. According to
Hopper et al. (1995), positivist research in accounting has an “undeniable impact”
(521) on the academy because it provides a “cloak of responsibility and prestige”
(522) with its scientific claims. Positive theories of accounting have been labelled
Chapter 2 Methodological Issues 23 as “factual, technical and objective” (Tinker et al., 1982, 167) because they are trying to explain and predict the “reality” or “what is” accounting practice (Chua,
1986a, Chua, 1986b, Tinker et al., 1982, Watts, 1995, Watts and Zimmerman,
1990).
Ontologically, positive accounting research is conducted in the material world which has “generalities and patterns waiting to be discovered” (Laughlin, 1995, 81) because the reality is seen as an “objective phenomenon that exists ‘out there’”
(Chua, 1986b, 583). Ontology is “the nature of being or reality” (Dillard, 1991,
11). Accountants see themselves engaged in the society which has an objective, value-free and real reality which is independent from the researcher (Chua, 1986a,
Chua, 1986b, Dillard, 1991, Hines, 1989, Morgan, 1980). Positivist researchers attempt to describe, explain and predict by developing hypotheses to build theories that explain the observed phenomena. These theories are tested for their validity.
For example, Watts and Zimmerman (1986, 1990) , used positivist agency theory to understand, explain and predict the accounting choices made by managers in firms. They used a key assumption of positive accounting theory, utility maximization, to explain accounting choices by analysing the cost and benefit of selections within the economy. This was criticized by Sterling (1990, 102) as being the “blanket assumption”, and Chwastiak (1999, 438) as a “delusion that economic consequences of action are all that matters”.
This ontological assumption forms the basis of positivist epistemological and methodological assumptions used to represent empirical reality (Chua, 1986a,
Laughlin, 2004). Because the underlining ontological position of the positivist is
Chapter 2 Methodological Issues 24 that “the external reality is objective and external to the subject” (Chua, 1986a,
611), the role of researcher and observer is therefore independent of the outcome of the research. The researcher is separate from the observed and the observer’s subjectivity and this “plays no part in the process” (Laughlin, 1995, 67). The positivist researchers’ role is to explain, describe and predict accounting (Chua,
1986a, Hopper et al., 1987, Laughlin, 1995, 2004). rather than seek the explanations beyond the hypothesis and the available data set (Laughlin, 1995).
Positivist researchers are using methods which are bound by their underlying ontology. Based on the assumption that accounting is a social phenomenon that can be studied independently of organizations, accounting information can be regarded as neutral and value-free (Chua, 1986a, Hines, 1989). The aim of research is to describe, explain and to predict (Abdel-khalik and Ajinka, 1979). Therefore, the methods used by positive researchers are mostly structured and quantitative. The data used in quantitative methods are usually cross-sectional which are gathered selectively to test the hypotheses to achieve a particular result (Laughlin, 1995).
A number of positivist research studies can be found in the banking industry. They mainly examine the relationship between stock value and the accounting method used. For example, Barth et al. (1995) investigated assertions of critics of fair value accounting, by restating earnings and regulatory capital to reflect the fair value of banks’ disclosed investment securities. The sample comprises annual data from 1971-1990 for US banks whose financial statement data is on the 1990
Compustat Annual Bank Tape. They compared the usefulness of historical cost and fair value accounting for investment securities. They found that when using fair
Chapter 2 Methodological Issues 25 value accounting for investment securities gains and losses, bank earnings are more volatile than those calculated using historical cost. Banks would have violated regulatory capital requirements more frequently than was the case under historical cost accounting. However, this quantitative analysis cannot explain the rationale of choosing market value as the accounting method and how they violated the regulatory capital requirement.
Kothari and Zimmerman (1995) used 1952-1989 earnings and returns data to assess whether to use a price model or a return model as valid descriptors in typical valuation. Francis and Schipper (1999) have done a similar empirical test to the relevance of financial statements using 1952-1984 firm data. However, this research using conventional quantitative methods did not tell us the interrelationship between the organizations and their societal context. It is anticipated that the contribution of this thesis will demonstrate to the reader that social, political and economic factors are important.
Chen et al. (2005) analysed 23 banks and non-bank financial institutions in
Mainland China and Hong Kong over the period March 1999 to January 2004 using a simultaneous equations multivariate regression approach to measure the effects on the rival financial institutions of the partial privatization of the Bank of
China Hong Kong (BOCHK). They compared the cumulative returns of the
BOCHK over the Hong Kong financial returns and compared the cumulative abnormal returns of portfolios of rival financial institutions with those of BOCHK.
The empirical results indicate that most of the banks and non-bank financial institutions in Hong Kong reacted negatively to the conclusion draft of China’s
Chapter 2 Methodological Issues 26 entry into the World Trade Organization (WTO). It also indicated that HSBC had no significant reaction to the restructuring announcement and the listing announcement of the BOCHK. However, the Hang Seng Bank, the third largest bank in Hong Kong, suffered a loss after the announcement of the BOCHK listing.
Again, this research does not give any detailed information about the reason why
HSBC had no significant reaction to the announcement. They commented that “the results [here] are not surprising” because they assumed that the bank generates profit globally.
Furthermore, Lim and Randhawa (2005) measured the efficiencies of the production and intermediation stages11 performed by banks in Hong Kong and
Singapore from 1995 to 1999. They also compared the relative efficiency of banks in the two markets. The found that there was a statistically significant relationship between bank size and X-efficiency. Their results also show that HSBC is the most consistent performer in the production stage by using frequency analysis.
However, they did not provide any explanation about the reason why banks in
Hong Kong were more efficient than those in Singapore.
The studies reviewed above were based on hypothesis testing and statistical analysis to establish a relationship between different variables. These studies are consistent with the “positive extreme” described by Laughlin’s (1995, 2004) continuum. They reflect an ontology that is concerned with describing a generalizable independent objective reality. Researchers did not actively take part
11 Production stage refers to banks collecting deposits by using resources, labour and physical capital. Intermediation stage refers to the managerial expertise and marketing skills of the bank to transform deposits into loans and investments.
Chapter 2 Methodological Issues 27 in an investigation process in the field and required minimal input from field participants. The methods used to discover and describe the reality are based on quantitative information derived from questionnaires, databases and cross-sectional data analysis over a certain period of time. Because of the statistically assessable result, the positivist approach constrains the types of questions that a researcher can ask and the range of answers.
However, it is not easy to understand the interrelations of the organisation with the society it operates within by using the conventional accounting and banking research. Hopwood (1979, 145) commented on “how little we know about the actual functioning of accounting (banking) systems in organizations”. Morgan
(1988, 480) also commented that “the numerical view highlights those aspects of organizational reality that are quantifiable and built into the accounting framework, but ignores those aspects of organizational reality that are not quantifiable in this way”. Morgan (1988) contends, for example, that they do not take into account the social inter-relationship between people and the overall environment, including the social accountability, accounting for public interest and public interest which is especially important in the banking sector. He also noted that accountants interpreted “a complex reality partially, and in a way that is heavily weighted in favour of what the accountant is able to measure and chooses to measure, through the particular schemes of accounting to be adopted” (1988, 480). While some may argue that this is not the role of accounting, others disagree. For example,
Rappaport (1977) and Zeff (1978) argue that financial reports affect not only the behaviour of individuals and economic entities and their stakeholders, but that they also have an impact on the general public.
Chapter 2 Methodological Issues 28
2.2.2 Interpretive/ Relativistic studies
The subjective end of Laughlin’s (1995, 2004) continuum is interpretivism (refer to
Diagram 2.1). The interpretive approach, ontologically is non-realist, holding that social reality does not exist in any concrete sense, but is the product of the subjective and inter-subjective experience of individuals (Chua, 1986a, Covaleski and Dirsmith, 1990, Morgan, 1980). Accountants’ construction of reality and accounting is a social practice, and not only a market practice (Burchell et al.,
1980, Hines, 1989, Hopper et al., 1987). It assumes that generalizable empirical patterns do not exist and “the world is not material”. Rather “it is a projection of our minds” (Laughlin, 1995). The knower is not separate from the known, knowledge is relativistic. Therefore, the form of interpretivist studies is not contributed by prior theory. The theory is not constructing of what the researchers do. Researchers can only interpret social situations from the perspectives of the participants and themselves. This is not a theoretical position but relies upon the reflexivity of the researchers (Crapanzo, 1980, Rudkin, 2002, Van Maanen, 1988).
The role of a researcher’s observation is always a part of the process of the discovery of reality (Laughlin, 1995). There is an “attempt to preserve differences in perceptual powers since a belief in this variable and its importance in the discovery processes forms the foundation for this way of seeing” (Laughlin, 1995,
67).
The methodology of an interpretivist ontology is to describe, translate, analyse, and infer the meanings of events that occurred in the social world (Covaleski and
Dirsmith, 1990). The nature of the method used by interpretivist researchers is
Chapter 2 Methodological Issues 29 usually unstructured, ill-defined and qualitative (Laughlin, 1995). Data sought is heavily descriptive. This includes case studies, open-ended interviews, ethnography, direct observations through field studies and historical studies (Irvine and Gaffikin, 2006, Strauss and Corbin, 1990). These provide “rich descriptions of the social world, most particularly the meanings attached to actions and events in the language of its principal actors” and explore “unforeseen” relationships
(Covaleski and Dirsmith, 1990, 544). Sayer (1992, 102) noted that research conducted with this inter-subjective language allows “intelligible communication and effective interrelation among researchers who may have access to the research report”.
Although interpretive approaches using qualitative data provide richer descriptions of the social world, they are not without limitations. One common method used by interpretive approaches is ethnographic research, which has been criticized by
Tinker (2005, 115) as a “false starting point[s]” of slanting the subsequent appropriative and reconstructive phases of the research. It was restrained to the experience of the actor-subjects.
Covaleski and Dirsmith (1990) argued that such approaches are time-intensive and problematic as there are multiple interpretations when more than one researcher participates. Differing meanings attributed by the social actors challenge the concepts of reliability and validity, separating the researcher from the scientific community (Gaffikin, 1988).
Chua (1986a) also commented that interpretive research accepting institutional structures does not allow a critique from a different ideological lens. Interpretive
Chapter 2 Methodological Issues 30 approaches are not sensitive to major conflicts of interest between classes in society, and do not advocate radical change (Dillard, 1991).
Much research has been conducted by using interpretivist approaches in the accounting area. For example, some researchers claimed that social factors have been omitted in accounting researches (Burchell et al., 1980, Burchell et al., 1985,
Chua, 1986a, Chua, 1986b, Cousins and Sikka, 1993, Gaffikin, 2005, Hines, 1988,
Milne, 2002, Sikka and Willmott, 2005, Tinker, 2005, Tomkins and Groves, 1983,
Willmott, 1986). Cooper and Hooper (1987), Covaleski et al., (1990), and Gaffikin
(1984, 1988) have tackled the limitations of mainstream research approaches through alternate methodological foundations. However, few studies have been done in the banking area using these alternate approaches, and specifically in Hong
Kong, a significant world financial centre. Therefore, research approaches in the banking area can be enhanced by these accounting perspectives.
2.2.3 Middle Range Thinking
The research based on Laughlin’s description of the ontological, epistemological and methodological stances of the middle of the “three continuums” relating to methodology can be described by middle range thinking (Laughlin 1995, 2004).
He uses middle range combinations of theory, methodology and change, as shown in Figure 2-3.
The ontological assumption of middle range theory is that prior theories from other social situations could partially explain the sites explored. It assumes that
“skeletal” generalizations may be possible and that “skeletal” theory can be used to guide the research. Theory, according to Laughlin (1995, 2004), is ‘skeletal’,
Chapter 2 Methodological Issues 31 requiring empirical insights to complement and complete the understanding of any situation. The approach taken in this thesis is to use Institutional theory with
Middle Range Thinking to amplify and flesh out and structure the empirical detail of the HSBC site. This allows not just a theoretical understanding, but it provides explanations of the changes in the financial reports of HSBC over time, specifically changes in the presentation of the annual reports, chairman’s statements, and notes of account disclosures.
Laughlin further explained where middle range thinking is placed in his later work
(2004). He was more explicit about the assumptions of his methodology and method and clarified the links between the two. Laughlin (2004, 273) explained that
“in middle range thinking the ‘fleshing’ out of the ‘skeleton’ is a
key purpose for empirical engagement. To do this requires the
innovation that human subjectivity can bring, albeit in a way
which is not totally left to the observers to specify in actual
situations.”
The role of researchers is therefore “important and always part of the process of discovery” to provide meaning to the environment studied and at the same time be guided by prior knowledge and theoretical insights (Laughlin, 1995, 80).
The methods appropriate to a middle range position include both qualitative and quantitative analysis. It could be heavily descriptive but could also be analytical to support descriptive results. Unlike the positivist and interpretivist approaches,
Chapter 2 Methodological Issues 32 which assume that “everything is satisfactory and in need of preservation”,
Laughlin (1995, 2004) claims that middle range thinking permits researchers to question and conduct analytical inquiry. Also it is not limited by the exclusively qualitative methods which are usually followed by interpretivist researchers.
Middle range research in accounting includes studies with a contextual orientation that acknowledge the importance of social, political, and economic contexts in the accounting environment. According to the middle range approach, these contexts provide the “skeletal” basis for investigation.
Broadbent and Laughlin (1998) used Laughlin’s (1991) organizational change model to understand the effects of the new public management in the schools and general medical practices of the UK. The theoretical ‘skeleton’ is drawn from previous and current empirical studies. Broadbent et al. (2001) used institutional theory as a “skeletal” language to “amplify” the reactions of the general medical practitioners to unwanted changes in accounting and finance in the UK.
Richardson et al. (1996) have also utilized a middle-range thinking approach by using skeletal models to describe change processes and the role of accounting and the accountant in the changing context within an organization. They used
Hopwood’s (1990) model to look at the roles which accounting played in the change process. They also interpreted the disturbances in the organization by using
Laughlin’s (1991) model of organizations through the elements of subsystems, design archetypes and the interpretive schemes to identify changes in their case study.
Chapter 2 Methodological Issues 33
According to Laughlin (1991), organizations contain both tangible elements
(subsystems) which allow inter-subjective agreement, and two less tangible elements (design archetypes and interpretive schemes) which “give direction, meaning, nature and interconnection” (Richardson et al., 1996, 12). The interpretive schemes included the beliefs, values and norms of the organization.
Accounting can be viewed as an interpretive scheme in an organization. The design archetype includes the organization structure, decision process, and communication systems. Laughlin also develops four models of change – rebuttal, reorientation, colonization and evolution – to describe the ways an environmental disturbance took place in an organization. Rebuttal change involves changes in the design archetype and these changes have little impact on the organization.
Reorientation changes affect both the design archetype and the subsystems because the disturbance could not be rebutted and has to be accepted by the organization.
However, the interpretive schemes are unaffected. Colonization involved changes which are forced on the organization. Changes in the design archetype are caused by the environmental disturbance. The interpretive schemes change completely in the organization. Lastly, evolution change involves complete changes in the interpretive schemes. These changes will be accepted by all organizational participants freely without coercion.
Tinker et al., (1982, 192) emphasized the importance of the social context of accounting when we look into traditional areas such as cost and management accounting and financial accounting. They recognized that employees were affected by accounting when the employers and corporations used budgeting, motivating, coordinating and planning to control the behaviour of people within
Chapter 2 Methodological Issues 34 organizations. They argued accounting “cannot not be value-free and socially neutral” (1982, 167). Therefore, organizational and behavioural literature can provide alternative ways, such as a socio-historical perspective, to analyse the socially constructing role of accounting (Hines, 1988).
Hopwood (1983) also called for research that studies, analyses, and interprets accounting in the contexts in which it operates, to provide a basis for understanding and explaining accounting in action, because accounting is intertwined with organizational functioning. He further raised the criticism that accounting studies ignore social, economic and political contexts (Hopwood, 1985) and stressed the importance of understanding accounting in its organizational context and its implication in organizational change (Hopwood, 1987, 1990). He used case studies to illustrate that “the consequences of accounting interventions in the organization can disturb, disrupt and displace the organization” (1987, 230). Hopwood (1987) emphasizes the roles accounting can play in the processes of organizational change.
The roles of accounting therefore included “creating a quite particular visibility in the organization” (p.8), “functioning as a calculative practice” or “objectification of phenomena” (p.9) and “creating a domain of economic action” (p.10). Therefore, accounting is embedded in the processes of organizational change.
The following table (Figure 2-3) provides an overview of the three continuums – positivist, interpretivist, and middle range positions – and their underlining assumptions.
Chapter 2 Methodological Issues 35
Figure 2-3 Alternative research approach assumptions adopted from Laughlin (1995, 2004)
Positivist Middle range Interpretivist Ontological Objective, “skeletal” No generalizations belief generalizable generalizations possible, social (The view of world waiting to possible reality does not exist reality) be discovered independent of the
Ontology observer Role of theory All defining. “Skeletal” theory Unique to each (Relevance of Definable theory with some broad situation – no prior prior theory at with hypothesis to understanding of hypothesis outset of test relationships, to
Theory research) guide the research Role of Minimal. Structured. Reality does not exist observer/ Observer Observer important independently and researcher in independent and and always part of relies on the empirical irrelevant, only the process of observer’s subjective engagement discoverer of a discovery with past observation pre-existing knowledge and inter- reality, objective. subjective Knower separate from the known Data collection Questionnaires, Questionnaires, Documents, methods Documents documents, interviews, interviews, observations observations Data narrative Quantitative, Qualitative, guided Qualitative, structured by prior theoretical unstructured terms and concepts Data sought Cross-sectional Longitudinal, case Longitudinal, case data used study based. Heavily study based, heavily predominately descriptive but also descriptive numerical and analytical selectively gathered tied to hypotheses Conclusions Tight conclusions Reasonably Ill-defined and focus derived about findings, conclusive tied to on process not generalizable “skeletal” theory and outcome, answer empirical richness why, but empirically
Methodology rich in detail Low Medium Low Emphasis on Emphasis open to Emphasis on changing status radical change and changing status quo quo12 maintenance of status
Change quo
12 Societies and organizations are essentially stable and a controllable social order is assumed (Chua, 1986).
Chapter 2 Methodological Issues 36
2.2.4 The research approach of this thesis
As discussed in Section 2.2.3, middle range theory assumes that skeletal generalizations are possible. I am therefore using a skeletal approach to offer a broader understanding of HSBC’s politics, culture and financial disclosures. It allows me a way of understanding behaviour and decisions of people and interpretation gained from the use of language in documents and the texts. It also allows me to explore beyond the numeric. I seek to discover the impact of the handover of Hong Kong to China in 1997 on the financial reports of HSBC in the banking sector. The bank has survived since Hong Kong was leased to the British in 1864. I could not “tell the story” through a positivistic approach because it requires hypothesis testing and statistical analysis to establish a relationship between specified variables, and also has the assumptions of an objective reality.
Political and cultural effects can be observed but are not quantifiable or measurable in a meaningful way. However, HSBC’s financial reporting is influenced by powerful players, such as the government, accounting standard setters and their standards and Bank Ordinances which embed political influence in the banking industry. This thesis contributes a different approach to research in the banking industry.
On the other hand, the interpretivist approach is not suitable for this research because of my limited access to the organization. The methods used with an interpretivist approach rely mainly on field work, ethnography, narrative inquiry, historical studies and explanatory analyses, which require the researcher’s in-depth direct observation and perception to provide meaning to events occurring in the social world (Covaleski and Dirsmith, 1990). Since an immediate access to the
Chapter 2 Methodological Issues 37 organization was not possible, a middle range approach therefore provides me with flexibility in choosing an appropriate method to use in doing this research. A lot of archival material that was rich in information about the bank and history of Hong
Kong are available to me to provide an interpretation of the survival of HSBC. The importance of context in understanding the social systems in banking can be achieved by conducting a case study in the banking industry. Middle range thinking provides with me an analytical framework that can be used to build an understanding of the changing processes in HSBC. This study offers the unique position of being able to access literatures of both English and Chinese texts, and because I operate in both cultures I have a unique interpretive language that I can bring to the study to add the richness of “thick description” (Geertz, 1988).
Using skeletal theoretical generalization allows me to understand empirical results observed in the changes in HSBC’s financial reports. I am using institutional theory as a skeletal theoretical base and as a guide to my research. My own inter- subjective understanding of this theory is the important part of this research.
Accounting and banking research investigates accounting practice from social, economical, cultural and political points of view within the context in which it operates (Burchell et al., 1980, Carpenter and Feroz, 2001, Covaleski and Dirsmith,
1988, 1998). Institutional theory (refer to chapter three) stresses the role of myths and symbols, and is opposed to the idea of a social reality which is waiting for the researcher to discover and understand. Organizations are loosely coupled with their actual practices in order to achieve or retain legitimacy. Therefore, institutional theory, which is not inconsistent with middle range thinking, will be
Chapter 2 Methodological Issues 38 used as the skeleton theory of my research and is explored in detail in Chapter three.
Figure 2-4 Institutional theory as the skeleton theory
Institutional theory
Figure 2-5 Overview of institutional theory as the theoretical lens
Skeletal Theory: Institutional theory Middle Range Thinking
Hong Kong
Financial Theoretical lens Accounting
My own subjective understanding of this theory is the important part of this research. I also highlight the inter-subjectivity13 of the actors and their actions
13The world is experienced from the outset not as the private world of a single individual but as an inter-subjective world common to us all. “We interpret events in a manner which is identical for all practical purposes and assume that we all would have broadly the same experience if we were to change places. In this way, we routinely make sense of the other’s talk and action and bring off our own ‘acceptable’ activities” (Silverman 1975, 277).
Chapter 2 Methodological Issues 39
(Chua, 1986a). This was achieved through unstructured interviews (refer to appendix 1). Each interview then helps to create the context or frame of reference from which I drew.
Figure 2-6 Summary of the research approach and the middle range position. Middle range My research Corresponding chapter(s) Ontology “skeletal” HSBC financial reporting is Chapter 4 generalizations influenced by powerful players possible which included political influence in banking industry, standard setters. Epistemology “Skeletal” theory with Knowledge can be obtained by Chapter 6 some various methods experience. My generalization, of investigation supported by the empirical result from this skeletal generalization, gives the basis to understand the financial reporting changes in HSBC. Methodology Structured role of Institutional theory will be used Chapter 3 observer, important to guide my research. My own and always part of the subjective understanding of this process of discovery theory is the important part of with past knowledge this research. and subjective Methods: Questionnaires, The primary source of data is Chapter 5-7 documents, interviews, the annual reports of the bank observations from 1967 – 2005, websites of the bank, unstructured interviews with the employees of the bank. Qualitative, guided by The banking industry is used as Chapter 5-7 prior theoretical terms a case study to investigate how and concepts the bank survives through the handover from Britain to China, seen through the lens of Institutional theory. Longitudinal, case The history of Hong Kong and Chapter 4 study based. Heavily the bank will be discussed and descriptive but also further analysis of its survival analytical will be given. Reasonably conclusive Institutional theory will be used Chapter 5-7 tied to “skeletal” to explain the organization theory and empirical change. richness Change Medium Transition of Hong Kong from Chapter 5-7 Emphasis open to British rule to the Chinese radical change and government. maintenance of status quo
Chapter 2 Methodological Issues 40
2. 3 The research site
The organization chosen as the research site has a strong impact on the nature of the research undertaken. Therefore the chosen research site needs not only to offer scope for rich data collection, but also has the potential for me to think radically with flexibility about what is happening in the chosen organization. HSBC was selected as the research site because it is a major bank which provided a background rich in history and information about the market. HSBC is one of the largest banking and financial institutions in the world. It has listings on the Hong
Kong, London, New York, Paris and Bermuda stock exchanges. It has branches in
83 countries in Europe, the Asia Pacific region, the Americas, the Middle East and
Africa.
HSBC was established in Hong Kong in 1864 by the Scottish/British after Hong
Kong became a British Colony in 1846. The bank is still surviving after experiencing external environmental disturbance in 1997 when Hong Kong returned to Chinese rule. This study explores how the bank survives within the different cultural backgrounds of its business environment, through an examination of its annual reports.
2. 4 Data gathering for this thesis
The methods used in this research are found in the processes by which knowledge is gained. Method is intrinsic to the theoretical dimension because “the actual way of conducting the investigation can either be defined according to some theoretical model of how the observer should see or is more reliant on the implicit perceptual powers of the individual observer” (Laughlin, 1995, 67).
Chapter 2 Methodological Issues 41
Methods are the techniques or tools by which data is gathered and analysed, the way in which interviewing, note taking, observing, documenting, recording, and collecting any “knowledge” can be conducted, and the use of statistics both inferential (positivist) and descriptive (Covaleski and Dirsmith, 1990, McNeill and
Chapman, 2005, Ryan et al., 2002).
Laughlin refers to method as a “definable approach but subject to refinement in actual situations” and is “invariably qualitative” in middle-range thinking (1995,
80). I have used text analysis. For example, the theme in the text, pictures, number of pages, the use of persuasive language, and use of metaphor. Data is “heavily descriptive but also analytical” when it is sought by longitudinal studies based on case studies (Laughlin, 1995, 80). I have used a case study and have conducted informal interviews. The time span of my analysis of financial statements is from
1967-2004.
2. 5 Methods of data collection
There are some reasons for taking a particular institutional focus, as well as for selecting HSBC as the specific purview of interest. HSBC is an institution with a rich cultural and social history, which continues to have a remarkable influence on the nature of the society of Hong Kong. The British accounting system was linked to British rule throughout HSBC’s financial reporting. However, the Accounting
Standard Board (UK) shifted to international standards gradually.
The primary source of data is the annual reports of the bank from 1967 – 2004, websites of the bank, and informal interviews with the employees of the bank. The data collection for this research study was conducted through interviews,
Chapter 2 Methodological Issues 42 documentary evidence and archival materials of the major bank, and informal discussions. I also used secondary sources such as books about HSBC. Some of the materials used in this study were in Chinese, for example, radio broadcasts,
Chinese newspapers and television broadcast transcripts. I went to political texts, academics texts, and public places for research. I acknowledge that I have privileged sources but I have attempted to be broader. I cannot give equal weights to all sources because of the availability of materials, but I have made a conscious effort to access what I could and use what I could. This is adequate because it brings out both the richness and perceptions of both Chinese and Western views of the bank.
First, annual reports from 1967 were chosen because this year begins a period of radical political and social change in the Hong Kong environment. Laughlin
(1991) identifies such an event as a disturbance. There was a riot provoked by
China’s Great Proletariat Cultural Revolution14 in 1967 and this event coincides with a worldwide recession. Deng Xiaoping, the then deputy premier of China, first told the United Nations about the decolonization of Hong Kong in 1972.
Later, in 1974, he refused to extend the lease of Hong Kong, which is further discussed in this thesis. This led to the joint declaration, which set the return date of
Hong Kong to the Chinese as 1997, signed by Margaret Thatcher, the then UK
Prime Minister, and Zhao Ziyang at a ceremony in the Great Hall of the People in
1984.
14 The Cultural Revolution was launched by Mao Zedong, the then Chairman of the Republic of China in 1966 and ended in 1976. During the period of 1966-1976 there was class struggle, chaos, and millions of people were persecuted.
Chapter 2 Methodological Issues 43
A second source of data comes through unstructured interviews with the following persons:
An anonymous employee who, at the time or writing this thesis, is one of
the division managers of HSBC;
Mr. Vincent Cheng, who is the first Chinese Chairman of HSBC. He is also
a member of the Exchange Fund Advisory Committee of the Hong Kong
Monetary Authority. He was a member of the Legislative Council of the
Hong Kong Government from 1991 to 1995 and a Hong Kong Affairs
Advisor to China from 1994 to 1997;
Mr. Henry Chan, who is the current Deputy President of CPA Australia,
Beijing Division.
Their interviews were conducted between 2004 and 2008. Tape recorders have been used during the interviews for backup and the recordings were translated from
Chinese to English, and transcribed into interview schedules for analysis in appendix 2. For example, meetings and telephone conversations were arranged with interviewees who were busy or who the researcher was not able to visit.
Questions to the interviewee were asked directly to obtain information.
Thirdly, documentary and archival materials have been used to conduct the research. A summary of data sources is shown in Figure 2-7. Items used were the bank’s annual reports, memoranda, newspaper articles, legislation which included the Banking Ordinance in Hong Kong, reports from HKMA, and the Hong Kong
Chapter 2 Methodological Issues 44
Government’s policy paper. Stock Market reports with major indices, such as
Hang Seng Index, New York Stock Exchange (NYSE) and London Stock
Exchange (FTSE 100), were also used in the research. Some of the documents such as newspaper articles were recorded in Chinese, and translated by the researcher.
Information from the annual reports from 1967-2004 was analysed. For example, a time series graph was drawn from the financial statements for the profitability of the bank, and some key financial ratios were calculated. The notes of accounts were also analysed for bank disclosure. This data was compared with the information extracted from the interviews, newspaper articles, reports from the
HKMA and were used to support the argument of the thesis.
Figure 2-7 Summary of data used in this research
Method used in this research Quantitative method: Text analysis –
Annual reports (1967 – 2004) Qualitative method: 1. Unstructured Interviews –
- Mr. X, Division Manager of HSBC
- Mr. Vincent Cheng, Chairman of HSBC
- Mr. Henry Chan, Deputy President of CPA Australia (Beijing Division)
2. Documents and Archives–
- Newspaper articles
- Bank Ordinances of Hong Kong
- Hong Kong Government policy paper
Chapter 2 Methodological Issues 45
-Reports from HKMA
- Radio and television transcripts
The transition from British rule to Chinese sovereignty in 1997 can be considered as an environmental disturbance as described by Laughlin (1991). It is interesting to see the organizational and accounting changes by tracing the process the disturbance takes through the bank. The change of government of Hong Kong is shown to have led to a series of strategic moves by some large British firms, such as HSBC.
2. 6 Text analysis
Annual reports, according to Stanton and Stanton (2002, 478), can be viewed as formal documents produced in response to mandatory corporate reporting requirements, and in the pursuit of legitimacy. However, Hopwood (1996) argued that accounting data in the annual report is a highly sophisticated product of the corporate design environment and not merely a technical appendix.
Content analysis is a method of codifying the text or content of a piece of writing into various groups depending on selected criteria (Weber, 1988). It was defined by Krippendorff (1980, 21) as “a research technique for making replicable and valid inferences from data according to their context”. It is also a way to codify
“qualitative and quantitative information into pre-defined categories to derive patterns in the presentation and reporting of information” (Petty and Cuganesan,
2005, 45). According to Ingram and Frazier (1983), annual reports can be viewed as “an undisguised advertisement” or as “platforms for preaching [management’s]
Chapter 2 Methodological Issues 46 philosophies and [for] touting themselves and their companies” (p.49). Therefore, content analysis may give the researcher another way of understanding the “reality” of the company and is a good instrument to “measure comparative positions and trends in reporting” (Petty and Cuganesan, 2005, 45).
Petty and Cuganesan (2005) used content analysis in corporate social, ethical and environmental reporting of voluntary disclosures in Hong Kong. Data was taken from the years 1992, 1998 and 2002 to give a longitudinal account of voluntary intellectual capital disclosure (ICD). They found that companies are engaged in growing levels of voluntary ICD, which raises concerns about a potential lack of standardization and the ability to compare companies meaningfully by size and industry. They also concluded that listed companies disclosing intellectual capital in their annual reports generally achieve higher levels of growth than companies not disclosing. The motivation of disclosure is to promote financial growth through higher share prices.
Smith and Taffler (2000) examined chairmen’s statements in the companies’ annual reports by using content analysis in order to discover the importance of discretionary narrative disclosures, and relationship with bankruptcy. They identified 54 failed manufacturing and construction companies listed on the
London Stock Exchange and matched them with financially healthy non-failed companies by industry, financial year end, and turnover band between 1978-1985.
They used both word-based and theme-based content analysis. They concluded that the unaudited managerial disclosures provided in the chairman’s statement contain important information associated with the companies’ future profitability.
Chapter 2 Methodological Issues 47
It was proven that by analysing the disclosures in annual reports, researchers can discover some important information. This study uses content analysis as a method to inform the research of HSBC, analysing the Chairman’s Statements in the annual reports.
Content analysis is a mainstream methodology. It only counts the quantity and doesn’t count the quality. However, it allows the researcher to ask different questions. It also allows me to see things from different point of views. For example, the Chinese Chairman, Vincent Cheng, representing HSBC, has a very ceremonial role. The bank changes its ceremonial image from a Westerner to a
Chinese. Even in terms of the basic communication language, Mr. Cheng admitted that he could not understand everything at the Board meetings (Cheng, 2008).
Weber (1990, 62) acknowledged the limitation of content analysis, in that it is partly an art and depends on the judgement and interpretation of the researcher no matter how careful the researchers are. “Texts do not speak for themselves…The investigator must do the speaking and the language of that speech is the language of theory”; therefore researcher bias cannot be avoided. Moreover, content analysis assumes that frequency of occurrence directly reflects the degree of emphasis accorded to words or themes. However, this may not always be the case
(Weber, 1990). Words or sentences classified in the same category for data reduction purposes may not reflect the category to the same scope (Weber, 1990,
72).
I acknowledge that the limitations come from the researchers themselves, and their own personal limitations construct the capturing and reflection of the data. To
Chapter 2 Methodological Issues 48 mitigate this in this study, during the process of research I am always referring back and thinking of my part in constructing the story, and in doing so reflexively acknowledge this limitation.
Preston et al. (1996) explore the visual images such as photos in annual reports.
They tried to “open a critical dialogue focusing upon the images in annual reports with the recognition that their images are an important means by which corporations seek to represent themselves to various publics” (34). They argued that annual reports are “a visual medium through which corporations, one of the principal political, social, and economic institutions of the twentieth and twenty- first century, attempt to represent and, as we shall argue, constitute themselves” and not the outcome of accounting (Preston et al., 1996, 115). They concluded that image is “the reflection of a basic reality”, it “mask[s] and pervert[s] a basic reality”, “mask[s] the absence of a basic reality” and “constitute[s] rather than merely represent[s] reality” (Preston et al., 1996, 134). The annual report itself therefore created and provided different ways to see the “reality”.
Content analysis can be classified as a positivist approach in terms of Laughlin’s
(1995, 2004) middle range thinking. It is because it assumes that there is a generalizable world waiting to be discovered, in this case from the annual report. It also involves the process of coding the qualitative data in order to perform quantitative analysis and statistical testing. However, it cannot tell the whole story about the parties involved in the process of preparing the annual reports and the power behind the accounting context. Because of the limitations associated with content analysis, qualitative analysis will also be used in this research.
Chapter 2 Methodological Issues 49
Laughlin (1991, 209) argued that “organizational change can only be understood by tracing the process, track or pathway a disturbance/kick/jolt takes through an organization”. With a view to this, Institutional theory will be used as the
“skeleton” theory to explain the organization’s changes and to describe the power struggle between the bank its environment. This will further be discussed in chapters five to seven.
2. 7 Interviews
At the beginning of the research, I considered seeking access to HSBC and conducting formal interviews with the employees of HSBC. Letters and emails were sent to the office in Hong Kong. However, the reply was that the Public
Relationship Department was no longer available in Hong Kong after 1995. I could only conduct informal interviews with employees of the bank. Therefore, I needed to rely on other sources of documents.
Interviewees were selected for the research on the basis of their long-term association with HSBC or accounting professional bodies in Asia at the top management levels. The first interviewee, Mr. X, is a current employee of HSBC.
He was chosen because he is a close relative of my family and he is willing to share his opinion about the organization. He also advises me that it was very difficult to get the authorization from the bank for formal interviews in the Hong Kong branch, especially after 1997. However, I had to agree that he is to remain anonymous. He has been working with HSBC since he graduated from the US, starting as a management trainee. He also disclosed that the Hong Kong branch transferred all the historical archives back to London in the early 1990s. He suspected it may due
Chapter 2 Methodological Issues 50 to the uncertainty of the future after 1997, which is further explored in section
4.7.4. Two unstructured interviews were conducted by telephone during 2004.
The second interviewee, Mr. Henry Chan, is the Deputy President of CPA
Australia (Beijing Division). His opinions provided information from a different perspective than Hong Kong. He has a close business connection with the Hong
Kong branch because Hong Kong and China were considered as one division under
CPA Australia. Although Hong Kong and China have different accounting standards and reporting requirements, Mr. Chan commented that because of globalization and the increasing number of foreign investments in China, especially from Hong Kong, there is a need to understand both systems. He also explained that CPA Australia in China and the Bank of China have invited HSBC to conduct seminars and courses for their employees in China.
The interview questions were not fixed in format and content. They were conducted in an unstructured way which leaves both the interviewer and the interviewee at ease and therefore provides more information through an informal dialogue between them (Rice and Ezzy, 1999, Yin, 2003). With the informal conversation, I let the interviewees identify what is important and let them raise the issues. Only the interview with Mr. X was tape-recorded because the others did not allow me to. Not all the interviews were transcribed and translated by the researcher. The interviews were conducted in both English and Chinese. Only relevant information was condensed and summarized. The transcription focused only on answers that were relevant to the research questions. As I let the interviewees raise the issue, this informed what is considered as relevant.
Chapter 2 Methodological Issues 51
To sum up
This chapter has explored the methodological framework of this research. Both the positivist and interpretivist approaches to theorizing accounting in a banking context were considered. Both approaches were deemed insufficient for explaining the social and cultural motivations and implications of changes in the financial disclosures and reporting of HSBC. Instead, Laughlin’s Middle Range Thinking approach was adopted, which illuminates the social, economic, and cultural influences on accounting in the banking context. This approach, using both qualitative and quantitative methods (text analysis and unstructured interviews), was described as the means suitable for conducting this research. Institutional theory was used as a skeletal theory to support these investigations.
The next chapter explores institutional theory in detail and relates it to the case study. The chapter forms the basis and explanation of the way an understanding and development of the theory was achieved.
Chapter 3 Institutional Elements and HSBC 52
CHAPTER 3 INSTITUTIONAL ELEMENTS AND HSBC
In Chapter two, Laughlin’s organizational change model was introduced as a methodological approach for this thesis. This framework is built upon in this chapter using a theoretical lens through which data about HSBC’s accounting system can be interpreted. Institutional theory is used because it helps to organize and process information about an organization. It examines the relationship between the organization and its environment, in terms of how organizations are related and why they must make similar choices to survive. It therefore allows generalizations about organizational behaviour while at the same time allowing an in-depth analysis of a particular organization.
Section 3.1 will give an overview of institutional theory, section 3. 2 will explain the origin of the theory, section 3. 3 will discuss the institution elements, while section
3. 4 will identify some limitations of institutional theory. Lastly, section 3. 5 will discuss the extension of institutional theory.
3.1 Overview of institutional theory
Institutional theory contends that organizations are strongly influenced by their environments (Powell and DiMaggio, 1991). New institutionalism, a development of Institutional theory, recognizes that institutions operate in an environment that consists of other institutions, called an institutional environment (Powell and
DiMaggio, 1991). Each organization and institution is affected and influenced by
Chapter 3 Institutional Elements and HSBC 53 the outer environment through institutional isomorphism15. The theory contends that the behaviour of organizations is motivated by economic, political, social, and cultural forces in the society. They seek legitimacy by conforming to norms and rules that are acceptable to the society. Organizations need to establish legitimacy with the society in order to survive. The main objective of the organization in this environment is to survive. Institutional theorists have been able to answer why there is a direct relationship between organizations and institutions, and how they affect each other. Therefore, institutional theory can be used to explain the relationship between institutions and organizations and the reasons for the organizational change, and facilitate generalizations about organizational behaviour (Powell and DiMaggio,
1991, Scott and Meyer, 1991).
Institutional theory provides a theoretical viewpoint through which information about HSBC is interpreted. Through the lens of institutional theory the way HSBC relates to its environment, and the reason why the bank adopts certain cultures and structures, is explored.
3.2 The origins of institutional theory
Institutional theory originated in economics, political science, and sociology studies and was rooted in the late 19th century16 (Scott, 2001). It is important for institutionalists to understand the past in order to explain the present. Neoclassical economic theory dominated until the 1970s when economists focused more on the
15 Institutional isomorphism holds that organizations tend to become homogenous over time. This will be discussed in detail in section 3.3.3. 16 There were three most influential institutional economists at the turn of the century, Thorstein Veblen, John Commons and Westley Mitchell. They all criticized conventional economic models because of their “unrealistic assumptions and inattention to historical change” although they have different views (Scott, 2001, p.3).
Chapter 3 Institutional Elements and HSBC 54 economic system as part of the total social system (Irvine, 1999). The assumptions underlying neo-classical economics have been challenged by institutional theory, for example, that it “overemphasized the uniqueness of economic systems and underemphasized the value of analytic theory” (Scott, 2001, 5).
On the American scene, some political scientists, such as Wilson, Burgess and
Willoughby, in the early 1900s grounded institutional analysis in “constitutional law and moral philosophy” (Scott, 2001, 6). Scott (2001) argues that Bill and Hardgrave criticize Wilson, Burgess and Willoughby because they focus mainly on formal structures and legal systems, were conservative and largely nontheoretical. He also argues that there were several strands of institutionalism in sociology, for example
Friedland and Abbott, Friedland and Alford, Durkheim, Parsons, DiMaggio and
Powell, Mead, Berger and Luckmann, and Merger and Rowan. Durkheim emphasized the important role played by symbolic systems and these systems were described by him as social facts which were viewed as both external and coercive
(Scott, 2001, 13). Moreover, Max Weber had a vital influence on institutional theory. He argued that the social sciences were fundamentally different and therefore needed an interpretive approach to explain reality. He identified
“institutions as separate from the organizations which they influenced” (Irvine,
1999, 73).
Organizations are distinguished as “distinctive types of social forms” in modern organization studies (Scott, 2001, 21). Institutional theories explain how these organizations are structured, and how they perform in the environment. Weick
(1996) emphasized the importance of social context, commenting that organizations
Chapter 3 Institutional Elements and HSBC 55 are “externally controlled by their social contexts” (1996, 567-568), which were determined by “what people take for granted, and consider legitimate, and are willing to pay as the price” (1996, 567-568).
The “new institutionalism” or sociological study of organizations began in the 1970s with Meyer and Rowan (1977) and Zucker (1977). Meyer and Rowan proposed that institutional rules are myths and based their work on Berger and Luckmann’s (1966) concept of institutions, emphasizing the impact on organizational forms of changes in the institutional environment, which is a macro argument. Zucker (1977) further stressed the micro foundations of institutions, such as the power of cognitive beliefs to anchor behaviour. Meyer and Rowan (1977) and Zucker (1977) argue that institutions are socially constructed templates for actions maintained through ongoing interactions.
DiMaggio and Powell (1983) developed institutional theory from the macro perspective and identified three mechanisms of institutional isomorphic change
(coercive in section 3.2.3.1, mimetic in section 3.2.3.2, and normative in section
3.2.3.3) which cause organizations to become increasingly alike in the organizational field. They also emphasized structural isomorphism, which will be discussed in section 3.3.2. These constructs have formed the basis of much research from that time onwards, such as Carruthers (1995), Dillard (2004), Mezias (1990), and Oliver (1991).
Porter (1996) on the other hand, from a “micro” perspective, suggested that the study of organizations as “critical contexts” has not been given much attention and called for research on the “internal, organizational environment affecting behaviour”
Chapter 3 Institutional Elements and HSBC 56
(Porter, 1996, 264). This research uses institutional theory to understand how the
Hongkong and Shanghai Banking Corporation (HSBC), given its own unique and rich history as a former colonial bank with different cultures and organizational structure, responded to institutional pressures.
3.3 Institutional elements
Institutionalism is a theory that emphasises developing a sociological view of institutions. As argued by Scott (2001), it can be viewed as emphasizing the transformations of organizations and the impact of the environment on the organization. Institutional theory further focuses on the environment, which consists of social and cultural forces, not only the task-related information and production resources. Organizations are seen to be more than production systems. They are also social and cultural systems (Scott, 2001). It has explanatory power for the way institutions interact with society and how they affect society. It examines the role of social influence and pressures for conformity to social expectations in shaping organizational rules (Oliver, 1997). It is important because it provides a way of looking at organizations apart from the traditional views of economics. It recognizes that institutions operate in an instituted environment which consists of other organizations. According to Smith, Ferrier and Ndorfor (2002, 315) institutional theory also includes “actions [that] are based on social importance and gaining legitimacy, not maximizing utility and efficiency”.
According to Selznick (1957, 129, 1996), institutionalization is “something that happens to an organization over time, reflecting the organization’s own distinctive history, the people who have been in it, the groups it embodies and the vested
Chapter 3 Institutional Elements and HSBC 57 interests they have created, and the way it has adapted to its environment”. It “ traces the emergence of distinctive forms, processes, strategies, outlooks, and competences as they emerge from patterns of organizational interaction and adaptation” (Selznick, 1996, 271).
3.3.1 Definition of ‘institutions’
Scott (2001, 48) defined institutions as
“social structures that have attained a high degree of resilience.
[They] are composed of cultural-cognitive, normative, and regulative
elements that, together with associated activities and resources,
provide stability and meaning to social life. Institutions are
transmitted by various types of carriers, including symbolic systems,
relational systems, routines, and artifacts. Institutions operate at
different levels of jurisdiction, from the world system to a localized
interpersonal relationship. Institutions by definition connote stability
but are subject to change processes, both incremental and
discontinuous”.
Summing up, it can be said that institutions are social structures based on rules, norms, taken for granted, formal or informal, regulated social behaviour, and systems of cultural meaning. “Institutions may be … carried by structured activities in the form of habitualized behaviour or routines” (Scott, 2001, 80).
Jeppeson (1991) also argued that institutions are transmitted by being embedded in carriers. An example of an institutional carrier affecting the banking and
Chapter 3 Institutional Elements and HSBC 58 accounting sectors is Accounting Standards and Banking Ordinances. Banks are viewed as subject to “highly developed technical and institutional pressures” and facing both efficiency and effectiveness demands as well as pressures to conform to procedural requirements (Scott and Meyer, 1991, 123).
HSBC could be considered as an institution because it is a former colonial bank in
Hong Kong. It is operating in a highly competitive environment which is regulated by laws and regulations. As mentioned in chapter one, HSBC has been in Hong
Kong for more than 150 years and continued to operate successfully after the transition of sovereignty from Britain to China. The bank struggled but resisted the changes threatened by social and political pressures to maintain legitimacy. Other institutions in this study include the Hong Kong Government, Bank of China, the
Accounting professional body in Hong Kong, the accounting standards, and respective legislations.
3.3.2 Institutional isomorphism
Organizations tend to become homogenous in both structure and process over time.
They compete not only for resources but for political power and legitimacy. The concept of institutional isomorphism is therefore a useful tool to understand “the politics and ceremony that diffused throughout the modern organizational life”
(DiMaggio and Powell, 1983). According to Hawley (1968), isomorphism is a constraining process which forces one organization to conform to other organizations facing the same set of environmental conditions. Meyer and Rowan
(1977, 340) explained that “organizations are driven to incorporate the practices and procedures defined by prevailing rationalized concepts of organizational work and
Chapter 3 Institutional Elements and HSBC 59 institutionalized society. Organizations that do so increase their legitimacy and their survival prospects, independent of the immediate efficacy of the acquired practices and procedures.” The effect of institutional pressures, as concluded by DiMaggio and Powell (1983), is to increase the homogeneity of organizational structures in an institutional environment. The tendency for organizations toward homogeneity was called “isomorphism”.
There are two types of isomorphism: competitive isomorphism and institutional isomorphism. Competitive isomorphism arises from market forces as an organizational response, as a result of competitive pressure. On the other hand institutional isomorphism arises from competition for political and organizational legitimacy other than competition for resources. DiMaggio and Powell (1983) mainly focus on institutional isomorphism, which emphasizes that organizations do not only compete for resources but for long-term survival. HSBC was established in
Hong Kong with severe competition, and had to compete for political and organizational legitimacy as well as for resources as a ‘local’ bank.
The three mechanisms affecting organizations’ adaptation of similar structures
(isomorphism) proposed by DiMaggio and Powell (1983) are: coercive isomorphism, mimetic isomorphism and normative isomorphism. Therefore, institutional theory is a theory that can “explain observed structural similarities between organizations (e.g. Institutional isomorphism)” (Carmona et al., 1998, 119).
The three mechanisms are discussed in the next three sections.
Chapter 3 Institutional Elements and HSBC 60
3.2.3.1 Coercive isomorphism
The first consideration is coercive isomorphism (DiMaggio and Powell, 1983) or the regulative pillar (Scott, 2001). Coercive isomorphism can result from formal and informal pressures by the society, other organizations, and the state. For example, it emanates from the government though regulation and pressures from society through public opinion, or from both (Siegel et al., 1997). The more the reliance and dependence of an organization on one source of important support, the more it will change isomorphically to resemble the more successful organization in order to meet public expectations and demand. Tolbert and Zucker (1983) observed that the higher the coercive pressures on an organization the quicker the rate of adoption of new structure. Moreover, increased adoption builds legitimacy in the institutional environment, accelerating the rate of adoption of a new structural form.
Organizations act in accordance with the rules and regulations in order to achieve and maintain legitimacy and even their changes may be ceremonial (DiMaggio and
Powell, 1983). They would like to project an image to various stakeholders that are responsive to the preferences of the society in which they operate.
3.2.3.2 Mimetic isomorphism
While coercive mechanisms are from outside the organization, mimetic mechanisms involve internally initiated change in response to uncertainty (DiMaggio and Powell,
1983). DiMaggio and Powell (1991) described mimetic isomorphism as how organizations “model themselves on other organizations” which are perceived to be more legitimate or successful, when the goals and environment are ambiguous and uncertain. Organizations replicate the practices of other organizations which
Chapter 3 Institutional Elements and HSBC 61 become taken for granted on the assumption that such practices are culturally supported and conceptually correct (Scott, 2001). Newcomers in an industry will try to imitate their successful seniors and attempt to match the industry leader (Siegel et al., 1997, Tolbert and Zucker, 1983). Organizations adopt certain procedures, policies and systems to achieve conformity with institutionalized rules and legitimacy, to assist in gaining society’s continued support (Ang and Cummings,
1997, DiMaggio and Powell, 1983, Scott and Meyer, 1991). The fewer the alternative models in a field, the faster the rate towards isomorphism. The more technology is uncertain and goals are ambiguous, the greater the rate of isomorphic change.
3.2.3.3 Normative isomorphism
A third mechanism of organizational change is known as normative isomorphism, which stems primarily from professionalization. Its basis of legitimacy is morally grounded, through university specialists and professional networks which provide training, certification, and accreditation. Professionalization can affect isomorphism
(DiMaggio and Powell, 1983). Professionals such as accountants and lawyers have strong ties with their professional bodies. These professional bodies promote normative standards and determine generally acceptable professional behaviour.
They affect the norms and values embedded in the act of management.
The filtering of personnel is an important mechanism for encouraging normative isomorphism. Personnel flows within an organizational field are further encouraged by structural homogenization, such as the existence of common career titles and paths with meanings that are commonly understood. A lot of professional career
Chapter 3 Institutional Elements and HSBC 62 tracks are closely guarded, both at the entry level and career progression. Entrants to professional career tracks who manage to escape the filtering process are likely to be subjected to pervasive on the job socialization (DiMaggio and Powell, 1983).
The more structured a field (with centres and hierarchies, etc), the more the isomorphism will rise.
3.3.3 Decoupling
The three mechanisms of isomorphic change drive organizations to adopt similar structures and practices. Organizations not only compete for financial and economic resources, but also for institutional legitimacy. However, adopting institutionally acceptable practices may not increase the organization’s efficiency. More importantly, presenting an acceptable public image is the key to survival. Therefore, there is a tension between the technical requirements and the institutional requirements imposed on organizations. Meyer and Rowan (1991, 356-359) and
DiMaggio and Powell (1983) proposed that organizations could decouple the structural features of the organization from its primary activities to resolve this conflict. Decoupling is the activity whereby “to maintain ceremonial conformity, organizations that reflect institutional rules tend to buffer their formal structures from uncertainties of technical activities … building gaps between their formal structures and actual work activities” (Meyer and Rowan, 1977, 30). Formal structure has more to do with “the representation of organizational-self than with how things actually transpire within the organization”, which is a sort of “symbolic window-dress” (Carruthers, 1995, 315) adopted by the organization. Organizations can show compliance with norms and values that the public expects and demands by
Chapter 3 Institutional Elements and HSBC 63 having ceremonial structures and practices, while not affecting the actual ways of working. Scott and Meyer (1991) and Scott (1991) argue that accounting can be used to satisfy external elements, while ‘shielding’ internal processes from intrusion by these external elements. Accounting procedures such as budgeting serve the role of shielding internal processes when they are financially dependent on external sources. Meyer and Rowan (1991, 51) commented that “modern accounting creates ceremonial production functions, and maps them onto economic production functions. Monetary prices, in post-industrial society, reflect a host of ceremonial influences, as do economic measures of efficiency, profitability or net worth.”
Accounting changes because of the changes in societal preferences or institutions.
Although this analysis may not enhance the efficiency of HSBC’s operations, nevertheless, presenting an acceptable public image is important if the organisation is to survive. This action was described by Meyer and Rowan (1977) as decoupling.
3.3.4 Legitimacy
The tendency of organizations to strive to strengthen their ‘legitimacy’ within their environment can be seen through institutional theory (Mizruchi and Fein, 1999).
Legitimacy in the institutional environment helps ensure survival of the organization. It is also the driving force of organizations to institutional isomorphism in order to survive. It is explained through two isomorphic processes – coercive and mimetic processes. These processes lead to the ‘cloning’ or homogenisation of organizational practice or operations.
Legitimacy could be achieved if organizations operated with the standards and norms of their corresponding institutional environment. It can be viewed as a
Chapter 3 Institutional Elements and HSBC 64 resource that helps to acquire more tangible resources that directly increase the chance for survival of an organization (Singh, 1996). Suchman (1995, 573) defined legitimacy as the “generalized perception of assumption that actions of an entity are desirable, proper, or appropriate within some socially constructed system of norms, values, beliefs, and definitions”.
Organizational legitimacy can be achieved by the use of accounting. The institutional environment within which the organization operates is characterized by the development of rules and requirements to which individual organizations must conform if they are to achieve legitimacy and receive support (Meyer and Scott,
1992). The acceptance of legitimacy of economic and technical bases for action can be demonstrated by using the accounting procedures. Accounting therefore can provide a basis for enhancing organizational legitimacy through the institutional environment. Meyer and Scott (1992, 235) described “….accounting structures are myths … [which] describe the organization as bounded and unified, as rational in technology, as well-controlled and as attaining clear processes. The myths are important: they help to hold the organization together with their justifications …
[and] they legitimate the organization with the controlling external environment.”
3.3.5 The significance of the founding of an organization
Scott (1987) identified one of the institutional elements affecting organizational structure as “imprinting” at the time of its founding. Scott (1995, 2001, p.18) later suggested that over the “natural history” of an organization, it developed “distinctive structures, capabilities and liabilities”. Institutional pressures cause founders to incorporate institutionally favoured characteristics in the hope that their
Chapter 3 Institutional Elements and HSBC 65 organizations are projected as legitimate (Meyer and Rowan, 1977). An organization tends to maintain certain practices adopted at the time of its formation
(Kimberly, 1975, Mezias, 1990, Scott, 1987). Therefore, historical factors are very important for an organization. The perception and development of an organization are “more important than market forces in shaping the characteristics of that new organization” (Dacin, 1997, 47). The founder has a great impact on the structure and accounting practices of the organization he or she establishes. The characteristics and practices often become institutionalized in the organization’s culture. New organizations, which are “legitimate subunits of the large social system”, must comply with the structures and norms if they are to be successfully established with legitimacy (Dacin, 1997, 52).
3.4 Limitations of Institutional theory
The following discussion explores assumptions of Institutional theory and aspects neglected by Institutional theory.
3.4.1 Assumption of organizational passivity
Institutional theory describes the general processes resulting from institutional pressures that cause organizations to resemble each other. It provides various reasons for organizational changes, including legitimization, responses to uncertainty, and professionalism. However, it does not account for the unpredictable nature of organizational change. Individuals are assumed to be primarily motivated by a desire to conform to institutional pressures. Therefore, it has been criticized for its “overly passive conception of individual action”
(Covaleski and Dirsmith, 1988, Roberts and Greenwood, 1997, 368).
Chapter 3 Institutional Elements and HSBC 66
Ang and Cummings (1997, 235) claimed that researchers often disregard “individual organizations’ ability to respond proactively, creatively and strategically to institutional influences” because institutional theorists assume organizations are passive players. They focus on the banking industry, which is operated in a highly institutionalized environment with stringent banking legislation. They suggested that the propensity of banks to conform to or resist institutional pressure depends on the nature of institutional pressures and financial capacity to resist institutional influence. Large banks would attempt to reshape institutional rules and models by building their own goals, actions, and procedures directly into the institutional environment.
Theorists have extended institutional theory arguments to include interest and agency (e.g. Powell and DiMaggio (1991), Mezias (1990), and Oliver (1991)).
Goodrick and Salancik (1996) argued that uncertainty provided discretion.
Organizational influences on practice will be greatest when institutional standards are most uncertain. Organizations will select alternative practices without loss of legitimacy. In uncertain situations, the organization may frame strategic choices.
Oliver (1988) suggested that a strategic choice perspective was most consistent with her findings on why organizational isomorphism occurred. Organizations seemed to be “loosely coupled” to their environment and therefore the organization may go through a selection process to resist or adopt homogenizing pressures.
Institutional isomorphism is not straightforward and organizational responses, with institutional elements such as coercive, mimetic and normative, are adopted in various degrees (Montogomery and Oliver, 1996). Oliver (1991) further proposed
Chapter 3 Institutional Elements and HSBC 67 that organizations respond to institutional pressures. Therefore, a passive response by the organization could not be assumed. She argues that organizations can make attempts to resist institutional pressures and proposes that institutions are variables in a selection process of alternative strategies that constitute different degrees of resistance to institutional pressures. Bloodgood and Morrow (2000) further develop
Oliver’s insight and suggest that institutional forces guide strategic change and demonstrate how the perceptions of choice, determinism and uncertainty influence the types of strategic changes that are developed. Therefore, organizations are not necessarily conforming passively to institutional influences. They have discretion and proactively shape institutional norms.
3.4.2 Lack of explanation of how institutions change
Institutional theory has been criticized for ignoring how institutions are created, changed and reproduced (Barley and Tolbert, 1997), and because there is no universal definition of an institution (Scott 1995; 2001). Zucker (1977, 728, 1983,
2) argues that institutionalization is both “a process and a property variable”. It could be seen as an entity, cultural or social system, which addressed the question put by various theorists: “why” an institution happens. It can also be seen as a process, which developed over time, of regulative, normative, or cognitive systems which are capable of “providing meaning and stability to social behaviour” in various degrees (Scott, 1995, 64). The two observations are closely related but are, however, different.
Burns and Scapens (2000, 6) further commented that an institution can be regarded as “imposing form and social coherence upon human activity, through the
Chapter 3 Institutional Elements and HSBC 68 production and reproduction of settled habits of thought and action”. At the same time, it evolves through a process of routinization of human activity. Therefore, there is a duality between action and the institutions which structure that activity.
Institutional theory has also been criticized for paying insufficient attention to changing institutional systems in the past (DiMaggio, 1988, Scott, 1995). Fligstein
(1985) explained that the perceptions of institutional constraints are important factors that determine to what extent organizational change will occur. He emphasizes that “the leaders of organizations watch one another and adopt what they perceive as successful strategies for growth and organizational structure” (Fligstein,
1985, 389). Organizational change will occur in an environment led by what key powerful actors perceive and by their ability to implement change.
Barley and Tolbert (1997) examined how patterns of interaction lead to the emergence of a new institution. They argued that social behaviours constitute institutions over time, while institutions constrain action at a moment in time. They also suggested that individuals and organizations can deliberately modify and eliminate institutions through choice and action. The question of how institutions change received increasing attention from institutional theorists. For example,
Kraatz and Moore’s (2002) empirical study17 showed that institutional changes that take place would be strongly impacted by various organizational and environmental factors. The skills, values, and cognitions of powerful actors were important in such a way that they can significantly affect decision processes.
17Kraatz and Moore suggested that the propensity of liberal arts colleges to adopt previously illegitimate professional programs was affected by the immigration of presidents from less prestigious colleges on the periphery of the field.
Chapter 3 Institutional Elements and HSBC 69
Furthermore, Greenwood et al. (2002), through the examination of the evolution of chartered accountants, suggested that the level of organizational fields such as professional associations are important entities. They showed how associations played a role in the process of collectively defining and redefining the institutional logic. The degree of emphasis and importance of associations varies according to the stage of the change process.
Siti-Nabiha and Scapens (2005) further addressed the processes of change and focused on both internal and external institutional influences. Their interpretation is that decoupling can be “the working out of a complex and dynamic process of resistance to accounting change” (Siti-Nabiha and Scapens, 2005, 67). Therefore, it is useful to incorporate Lauglin’s (1991) organizational change model to explain how an organization changes in response to external disturbances.
3.4.3 Neglect of the issues of power
Institutional theorists do discuss power, but they mostly concentrate on emphasizing cultural factors rather than power and interest. Some critics of institutional theory believe that institutional theory should resurrect the focus on interest and power and not just culture (DiMaggio, 1988, Perrow, 1985). Carruthers (1995) suggests that new institutionalism may be “concern[ed] with culture and taken-for-granted meanings to be able to discern the conflicts that abound in organizational life” and
“focus on myth and ceremony”. Therefore, it may neglect issues of power. An early institutional theorist, Stinchcombe (1968, 107), defined an institution as “a structure which powerful people are committed to some value or interest”. He emphasizes that power is highly related to the historical preservation of patterns of value.
Chapter 3 Institutional Elements and HSBC 70
Miller (1994, 1) claimed that institutions’ systems of interest “greatly modify the operation of power in modern societies” because the holders of resources are systems of “massive power”. He also argued that this power was tied to the roles and legitimated authority. As claimed by Fogarty (1996), the role of the state was a central factor in the conception of power within institutional theory. The role of the
Securities Exchange Commission (SEC) in the audit market was highlighted in his study of peer review of auditors in the United States. The polity embedded authority into the organizational field through action or inaction and were “highly constrained in their maneuver and influence” (Jepperson and Meyer, 1991, 214).
Powell and DiMaggio (1991, 191) suggested that “elite intervention may play a critical role in institutional formation. Once established and in place, practices and programs are supported and promulgated by those organizations that benefit from prevailing conventions”. As a result, “elites may be both the architects and products of the rules and expectations they have helped devise” (Powell and DiMaggio, 1991,
191). This is demonstrated by the example of the influence of modern professions which establish their control over the selection of new recruits, the socialization of successors, and control over the conditions of incumbency. “Once such a system of control and reproduction is in place, it almost inevitably attempts to expand its jurisdiction. Skilled institution builders who gain from such a system of power will typically expend considerable effort to maintain their dominance” (Powel and
DiMaggio, 1991, 191).
Friedland and Alford (1991) argued that if institutions exist, they can manipulate or reinterpret institutionalized symbols and practices. Individuals are using different
Chapter 3 Institutional Elements and HSBC 71 institutional logics to serve their purposes. They pointed out that “[s]ometimes rules and symbols are internalized and result in almost universal conformity, but sometimes they are resources manipulated by individuals, groups, and organizations” (Friedland and Alford, 1991, 254). Covaleski and Dirsmith (1993) further concluded that institutional theory had failed to explain power, include political considerations, and interest-based behaviour in their study of practices and techniques (e.g. accounting) used by the then Governor of Wisconsin.
Pettigrew (1973) attempts to summarize the theory of organizational power and views politics in terms of attaining interest-based demands. He proposed that “as long as organizations continue as resource-sharing systems where there is an inevitable scarcity of those resources, political behaviour will occur” (Pettigrew,
1973, 20). Pfeffer (1981, 7) defined organizational politics as “those activities taken within organizations to acquire, develop and use power and other resources to obtain one’s preferred outcomes in a situation in which there is uncertainty or dissensus about choices”. When there are institutions being established or maintained or diffused, they must involve political behaviour as organizational interests compete for domination.
Dillard et al. (2004) suggested that institutional theory has lost concern with power and proposed that discourse analysis should re-emphasize the social construction and the importance of power in institutional processes. The focus on institutionalisation as an “achieved state” rather than an “unfinished process”
(Dillard et al., 2004) has overlooked the relative power of the organised interests and players involved. This may be the result of institutional theory’s focus on
Chapter 3 Institutional Elements and HSBC 72 institutionalization as an outcome or a state, rather than as a process (Powell and
DiMaggio, 1991). Fligstein (1985, 379) suggests that power is involved in “all important organizational decision[s]” and “must rest on some structural claim over resources” because organizational actors tried to take control of valued resources such as capital, information and outside connections.
3.4.4 Ignorance of the “micro” perspective
Institutional theory emphasis a “macro” perspective rather than a “micro” view which focuses on individual organization. Robert and Greedwood (1997, 350) claimed that the primary unit of analysis in institutional theory is the society, i.e. the organizational field. It emphasizes conformity rather than diversity. The micro process of institutionalization was neglected within institutional theory and therefore there is a need to understand the “complexity on the ways that firms learn of and adopt new forms of organizing” (Robert and Freenwood, 1997, 368).
According to Zucker (1991, 105), there was a variety of strategic responses by organization to similar institutional environments which represented “differentiation rather than isomorphism”. There were important differences between micro and macro point of views about organizations. She claimed that there is a need to have micromeasurement strategies when considering institutional theory versus resource dependence because it would be difficult to tell whether the adoptions constituted institutional isomorphism. Institutional theory may be just a “clever strategic response to external constraint” (Zucker, 1991, 104). However, a micro level study could give insight into the variants of organizational strategic responses and to similar institutional resources.
Chapter 3 Institutional Elements and HSBC 73
Burns and Scapens (2000) also commented that institutions tend to focus more on the macro level. For example, Mezias (1990) studies general accepted accounting principles at the society or organizational level of for-profit organizations. He called attention to the interorganizational level of analysis and the social structure in which firm actions are embedded in institutional environments. Burns and Scapens (2000) develop a framework for studying management accounting change at the organizational level and attempt to describe micro processes. They argued that management accounting has the potential to become institutionalized and contribute to the stability of organizational processes and to act as “a carrier of organizational know-how” (2000, 23).
Although institutional theory has been questioned for ignoring the micro- perspective, it is still useful to look at an organization, HSBC. It is useful to explain the institutionalized process whereby HSBC adopts the unseen institution of society.
It also helps to explains how accounting is an institutional element with powerful legitimacy potential. For example, the new HSBC adopted the institutionally acceptable practices by disclosing the analysis on advances to customers according to the HKMA and disclosing the method used by the bank separately (detailed in section 7. 3).
3.4.5 Problems with decoupling
Meyer and Rowan (1977) suggested organizations adopted the notion of loose coupling to explain the disconnection between formal structure and the organizations’ daily (technical) activities in the context of temperedness in an
“institutionalized environment”. Organizations adopt formal structure in order to
Chapter 3 Institutional Elements and HSBC 74 achieve legitimacy. However, according to Carruthers (1995), the linkage between technical and institutional factors and environment is not simple or straightforward.
Scott and Meyer (1991) proposed that organizations are subject to both technical and institutional pressures. A technical environment refers to organizations producing services, and in return rewards are granted for their effective and efficient control of production systems. Organizations that concentrate their energies on controlling and coordinating their technical processes are likely to attempt to buffer or protect their core processes from environmental disturbances. On the other hand, institutional environments are rules and requirements to which organizations must conform if they are to receive support and legitimacy. The requirements may stem from regulatory agencies authorized by a nation-state, professional or trade associations.
Organizations are therefore “rewarded for conforming to these rules or beliefs”
(Scott and Meyer, 1991, 123). However, it is difficult to distinguish between the two pressures and the “real world keeps confusing the two” (Carruthers, 1991, 318).
The more ambiguous it was to measure organizational performance, the more likely that organizations would decouple their structures from normal procedures.
Carruthers (1995, 318) commented that decoupling “allows an organization to maintain its institutionally prescribed appearances (via formal structure) without having to compromise actual operations”. It also endangers technical appearances and therefore has to be stage-managed. Legitimacy would be affected if the structures were decoupled from actual rules and procedures too obviously.
Carruthers (1995, 319) provided an example in accounting:
Chapter 3 Institutional Elements and HSBC 75
“If accounts are being used more to justify decisions than to
generate them, however, or to make decisions look good rather
than to make them rational, then we would say that the rationalized
form of accounting is decoupled from actual organizational
decision making. But to the extent that financial accounts are
obviously manipulable, or are seen to be politicized symbolic
window-dressing, their credibility as “neutral”, “impartial”, or
“objective” measures of organizational performance is undercut.
Whatever accounting manipulations are being performed, they
must be done “backstage” in order to be effective. It is hard to
maintain appearances if the decoupling becomes too transparent.”
Banks, such as HSBC, are viewed as subject to highly developed technical and institutional pressures. “They face both efficiency and effectiveness demands as well as pressures to conform to procedural requirements” (Scott and Meyer 1991,
123). Therefore, their administrative structures were expected to be larger and more complex than those facing less complex environments. They generally carry out tasks that combine complex technical requirement with a strong “public good” component (Scott and Meyer 1991, 123).
3.5 Extension of Institutional theory
A number of researchers have attempted to incorporate other theories to fill in the gaps and deficiencies of institutional theory. Some have included a resource-based view to demonstrate how the perceptions of choice, determinism and uncertainty influence the types of strategic changes managers are likely to develop (Bloodgood
Chapter 3 Institutional Elements and HSBC 76 and Morrow, 200018). Covaleski et al. (1993) added a political dimension to an institutional study of the use of case-mix accounting systems in the health care industry. Barley and Tolbert (1997) and Dillard et al. (1991) discuss the similarities between institutional theory and structuration theory. They argued that a fusion of the two would enable institutional theory to significantly develop a model of institutionalization as a structuration process. Oliver (1997) uses task environmental theory and institutional theory to investigate building firms in the Canadian construction industry. Oliver (1997, 118) concluded that institutional conformity resulted in benefits which exceeded “social endorsement and legitimation”.
Despite some limitations, it is still worthwhile to use Institutional theory by acknowledging them. Oliver (1991) identifies different strategic responses that organizations enact as a result of the institutional pressures toward conformity.
Oliver suggested that organizations “respond to institutional pressures that affect them” (1991, 145) by employing acquiescence, compromise, avoidance, defiance and manipulative strategies and not simply conform to them. She then suggested five institutional antecedents – cause, constituents, content, control, and context – for predicting strategic organizational responses to institutional pressures.
HSBC chose to manipulate its environment in order to maintain its legitimacy to resist pressure towards isomorphism. Since accounting can be used as a tool for legitimacy, annual reports will differ from the roles and expectations in a ‘de- coupled’ situation when the organization is under pressure. A situation of ambiguity
18This study uses a resource-based view to demonstrate how the perceptions of choice, determinism and uncertainty influence the types of strategic changes managers are likely to develop.
Chapter 3 Institutional Elements and HSBC 77 could exist in times of change and uncertainty in its external environment, such as public perception, government reporting requirement or uncertainty about the future of the organization. There may also be problems in responding to external institutional pressure or uncertainty about the organization’s culture. In the above mentioned ambiguous situation, an organization such as HSBC may respond by re- asserting its legitimacy using accounting as a powerful tool.
The next chapter (chapter four) will examine the history and development of HSBC, and consider the influences which were in place at that time, and highlights their impact on the development of HSBC’s unique culture, including their accounting and accountability.
Chapter 4 Historical Context 78
CHAPTER 4 HISTORICAL CONTEXT
4. 1 Historical influence
An organization faces continuing pressures from the outside as well as inside as it develops over time. These pressures determine the nature of its performance as perceived by society. HSBC was historically influenced by both the British culture as well the Chinese culture, internally and externally. The role of HSBC in Hong
Kong can be seen through the history of Hong Kong and the bank itself. HSBC shaped and was also shaped by the economic changes in Hong Kong. Especially following the disturbance of the handover of Hong Kong, HSBC’s role has changed with the “one country, two systems’ policy”. Therefore, understanding the historical influences can help to explain the way HSBC responded to institutional pressures through cultural and political mechanisms.
The historical context in which HSBC began in Hong Kong will be outlined in section 4. 2. The influence of the founder on HSBC and its early development of financial reporting is discussed in section 4. 3. External pressures on, and criticisms of, the financial arrangements of early HSBC are explored in section 4. 4. The expansion of the bank during the 1950s will be examined in section 4. 5. This historical influence has contributed to the development of the bank’s unique culture, structure and political influence. The currency system and HSBC’s role as a de facto central bank, and its ensuing political influence, are discussed in section 4. 6.
HSBC and the transition of Hong Kong will be discussed in section 4. 7 and following that the 1997 policy of “one country, two systems” and how it affects the bank is explored in section 4. 8. The development of accounting in Hong Kong is
Chapter 4 Historical Context 79 discussed in section 4. 9. The influence of institutions on both society and on the organization is emphasized by institutional theory. These institutions, defined by
Oliver (1991) as regulatory structures, government, laws, professions and public opinion, established the early culture of HSBC as a financing organization. These external pressures on the bank in relation to the financial reporting of the bank will be discussed in section 4. 10.
4. 2 The institutional context of early Hongkong and Shanghai Banking
Corporation
Hongkong and Shanghai Banking Corporation (now HSBC) began in Hong Kong, a
British Colony, in 1865, founded by Thomas Sutherland (Crisswell, 1981, HSBC
Holdings plc, 2004, King, 1983a). The importance of both internal and external institutional pressures and historic influences in HSBC’s use of financial reporting as a legitimizing activity will be discussed (as shown in Figure 4-1.
Figure 4-1 Institutional view of the internal and external pressure on the bank
Banking Law Historical influence: Founder
Scottish Principles HSBC Financial Users Statements
Chinese Accounting Culture
Chapter 4 Historical Context 80
An organization tends to maintain certain practices adopted at the time of its formation. This is referred to as organizational imprinting (Kimberly, 1975, Mezias,
1990, Scott, 1987). The organizational structure was imprinted at the time it was founded (Scott, 1987). Therefore, historical contexts are vital at the beginning of an organization. New organizations which are “legitimate subunits of the large social system” must comply with prevailing structures and norms if they are to be successfully established with legitimacy (Dacin, 1997, 52).
For HSBC, this is a significant matter for its success in gaining the trust of local investors and the Government of Hong Kong, particularly in relation to financial and accounting practices. At the time of HSBC’s establishment, the languages, cultures, and perceptions of transacting were totally different between the East and the West.
There were language barriers between the British and the Chinese. The business culture of Hong Kong was different from that of the West. There was no standard banking system or monetary system before Hong Kong became a colony of the
British.
The official record of the discovery of Hong Kong can be traced back using pottery and stone objects unearthed by archaeologists from beaches in Hong Kong. These suggest that there were people living in Hong Kong as early as six thousand years ago. According to the Hong Kong Special Administration Region (HKSAR) year book 2003, Hong Kong had population of about 3,650 which was scattered over 20 villages and hamlets, and 2,000 fishermen lived on board their boats in the harbour in the early years. It was a small fishing community and a haven for travellers and pirates in the South China Sea. The oldest Chinese settlements on Hong Kong
Chapter 4 Historical Context 81
Island are Cheuk Pai Wan – now known as "Aberdeen" and Cheung Sha Wan. The influence of the Scottish began with the naming of the places in Hong Kong. Until the British claimed it as a colony, Hong Kong was inhabited by farmers and fishermen. It was a fishing port before any trade with the West.
Figure 4-2 View of Hong Kong , George Chinnery (1852)
Western influence in China came about at the beginning of the 15th century due to increased trade in Chinese products, such as silk and tea through the Silk Road that stretched from north-western China to Eastern Europe. The Portuguese were the first to reach China in 1555 by sea, but the British dominated foreign trade in the southern region of Guangzhou during the early stages of the Western connection in
China. They were interested in Victoria Harbour, which was strategically located on the trade routes of the Far East, and was soon to become the “hub of a burgeoning entrepôt19 trade with China” (Hong Kong Government, 1992, 372).
Britain's presence in Hong Kong had its origins in the opium trade. In the 1830s the governments of Britain and British India were profiting hugely from this trade,
19 Entrepôt is a trading centre where merchandise can be imported and exported without paying import duties.
Chapter 4 Historical Context 82 which continued right through till 1917. When the Chinese tried to protect themselves against opium, the British subjugated them in what became known as the
First Opium War (1840-42) (Benton, 1983). During the Opium Wars with China in the 19th century, the British used the territory as a naval base. The local perception of the British was as invaders of their homeland. This perception therefore might have affected any business relationship with the British, especially when HSBC began to establish itself in 1865. The war ended by the Treaty of Nanking, signed on 29 August 1842, which ceded Hong Kong to the British to serve as a trading emporium for British merchants and a strategic navel base in the Far East. Lord
Palmerston, British Foreign Secretary at that time, referred to Hong Kong as “a barren island with hardly a house upon it” (Auyeung, 1997, Benton, 1983, Chiu,
1973).
Figure 4-3 Treaty of Nanking (1842)
The treaty reduced Chinese tariffs on British goods and opened five ports, including
Shanghai, to British trade and traders. From the Chinese point of view, this was the
Chapter 4 Historical Context 83 first of a series of 'unequal treaties' imposed on China by imperialist powers in the
19th century (Manning, 1997). Following additional conflicts with the Chinese in
1860, the British gained Kowloon opposite Hong Kong and the nearby Stonecutter’s
Island in the second treaty (Hong Kong Special Administration Region, 2002). The opening of the ports paved the way for HSBC to establish a local bank and facilitate trade and finance for the British and the East.
The third and last treaty was imposed by Britain in 1898, following the scramble for concessions precipitated by Japan's victory over China in the war of 1894-95
(Benton, 1983). By a convention signed in Peking in 1898, “North Kowloon and a large area of the mainland to the north of it and the south of Shenzhen River, together with 235 islands and a large body of sea around Hong Kong and in the vicinity of Mirs Bay and Deep Bay were leased to the British Crown for 99 years”
(Hong Kong Special Administration Region, 2002). Only the leased territories were required under the treaty agreements to be returned to China in 1997. The New
Territories account for 366 of the colony's 400 square miles. Without them, the areas ceded under the first two treaties would have been economically unviable.
Even with them the colony would have been unviable if Beijing withdrew its co- operation (Australia Parliament and Sinclair, 1997, Benton, 1983).
Hong Kong was gradually transformed from a fishing port to a major trade entrepôt because of the increase in trading between the East and the West. Hong Kong’s development into a commercial centre began with its founding as a settlement under the British flag in 1841. By an official proclamation signed on 7 June 1841, Chinese traders were openly invited to trade and stay in Hong Kong, where, as promised by
Chapter 4 Historical Context 84 the British, “they will receive full protection from the high officers of the British nation: and Hong Kong being on the shores of the Chinese Empire, neither will there be any charges on imports and exports to the British Government” (Chiu, 1973, 26).
The British declared Hong Kong a free port, which means no tax was charged on most goods that entered or left Hong Kong. They also exported their system of common law governing private property and civil rights, and created a professional civil service. The establishment of a local bank was important in providing foreign exchange facilities for the foreign merchants and lending resources for both the foreign and Chinese merchants.
The success of Hong Kong as an entrepôt was the result of the legal system and natural deep water ports. Szczepanik (1958) described the first hundred years of
Hong Kong as a century of growth of an entrepôt economy. Entrepôt trade flourished because Hong Kong has an ideal natural harbour, situated on the south coast of China and at the crossroads of major oceanic routes which made sea transport to China very convenient. As commented upon by Hui (1999), Hong
Kong, with other East Asian cities, was a regional centre where capitalist activities have been concentrated since the 1840s. Because Hong Kong is located on a major trade route of commercial activity in the region, the overseas Chinese in East Asia were provided with a centre facilitating long-distance trade, which has been a key factor in capitalist development.
During the 1860s, the finance of trade along the Chinese coast was not well developed, and most transactions were still handled by European trading houses rather than by banks. Larger and more sophisticated facilities were therefore needed
Chapter 4 Historical Context 85 by the local businessmen, and business leaders in Hong Kong required banking services, preferably from a bank that was locally owned and managed. The centrality of trade in Hong Kong’s economic life also led to the development of servicing industries to support trade, both international and regional. The international financial network, consisting of well-established British and American companies, such as Jardine, Matheson and Co., Dent and Co., and Russell and Co., gradually gave way to the development of modern banks because banking was largely done by these big merchant firms (Crisswell, 1981, King and Hongkong and
Shanghai Banking Corporation, 1987). This paved the way for the establishment of
HSBC.
4. 3 Birth of HSBC
Hongkong and Shanghai Bank (Hongkong Bank) was established in 1865 in Hong
Kong, with its Shanghai operation in 1866. According to King and Hongkong and
Shanghai Banking Corporation (1987), the beginnings of the group are found in the approval by the Legislative Council of the Hong Kong and Shanghai Bank
Ordinance (No. 5 of 1866) on August 14, 1866. HSBC was established by the banker Thomas Sutherland for the Hong Kong colonial administration, and not by the British Government. Local people in Hong Kong still refer to the bank as “the lion bank” because there is a pair of lion statues outside the HSBC headquarters, as well as on some banknotes.
The rapid economic growth and the demand for a local bank to meet the financial needs of the region paved the way for the establishment of the Bank. Banking services such as discounting and exchange were provided by merchants. As the
Chapter 4 Historical Context 86 pace of economic change gathered speed, the demand for banking services grew.
HSBC was the first bank operating in the Far East to be founded and headquartered in Hong Kong. Other banks at that time offering services in the Far East had been founded with their headquarters in cities such as London (King and Hongkong and
Shanghai Banking Corporation, 1987). The profits flowed out to wherever their home office was established. The business community and local residents of Hong
Kong wanted a bank where the benefits would flow to their own community and a bank capable of meeting directly the financing requirements of the expanding activities of Eastern-based merchants and of the several colonial and sovereign governments.
The English name of the bank denoted the area of operation, which was common at the time it was established (King, 1983). There was an early custom of writing the name of familiar Chinese cities as one word, for example, Peking as opposed to Pei- ching. Therefore, the name of the bank is written as ‘Hongkong’ rather than ‘Hong
Kong’. However, the British authorities usually referred to their colony as ‘Hong
Kong’ and to the Bank as the ‘Hong Kong Bank’. There was inconsistency when writing the full title of the bank between the government and the general public in
Hong Kong. The Hong Kong Government tried to pre-empt any further discussion by referring to the ‘Hong Kong and Shanghai Banking Corporation’ in the ordinance in the late 1930s (King, 1983). The bank’s Chief Manager and Chairman, Sir Arthur
Morse, refused to accept this as a fait accompli and therefore an amendment was included in a 1950 miscellaneous provisions ordinance (No. 37). It was the first time the bank retained the single word spelling in the bank’s name and was officially referred to as ‘The Hongkong and Shanghai Banking Corporation’.
Chapter 4 Historical Context 87
The Board of Directors of the bank decided to have a Chinese name for the bank. In order to gain recognition from the locals, all foreign firms at that time adopted
“officially recognized” Chinese names. DiMaggio and Powell (1983) referred to this process as institutional isomorphism and it could be described as a homogenization of organizations (Covaleski et al., 1993, Powell, 1985). For example, the Asiatic Bank was known as ‘Ho yin-hang’ in Hong Kong. The
Chinese name of the bank first appeared in 1881 on the bank’s notes20 (Collis, 1965,
King and Hongkong and Shanghai Banking Corporation, 1987). It helped the bank to maintain its own distinctive identity. Dacin (1997) argued that a newly forming organization has to follow a strong social structure and norms in order to establish itself successfully. It was important that HSBC was seen as “legitimate subunit” of
Hong Kong if they had to raise funds at the beginning (Dacin, 1997, 74). The
Chinese name of the bank at the establishment in 1865, 香港上海銀行 , was a literal translation of the English name of the company. Foreign firms usually adopted
‘officially recognised’ Chinese names in Hong Kong. The company attempted to create a more traditional Chinese image. In the mid-1870s, the Chinese name of the bank included the characters ‘hui-feng’, 匯豐, meaning ‘focus of wealth’, conjuring up a vision of streams of wealth flowing towards the bank. This was comparable to the Chartered Mercantile’s Shanghai name you-li, 有利, or ‘profitable’. The bank included its Chinese name on early notes. It gave the sense of ‘high principled’ or
‘regulated’. This was inspired by the Agra and United Service Bank, whose Chinese name was Ho-Chiu-la ‘hui-li yin-hang’ , 匯理銀行 . This Chinese character, ‘hui’,
20 It was a common practice for Scottish banks to issue their own bank notes.
Chapter 4 Historical Context 88 was also seen in the Commercial Bank Corporation of India. Later in 1888, the bank adopted the Shanghai variant term hui-feng or Wayfoong , 匯豐, because of popular Cantonese romanisation. ‘Wayfoong’ has been given the more literal but ahistorical translation ‘abundance of remittance’ (Collis, 1965, King, 1983b, King and Hongkong and Shanghai Banking Corporation, 1983, 1987). The Chinese characters on the banknotes were traditionally written in 1881 by the Chinese
Minister to London, Tseng Chi-Tse, a skilled calligrapher and friend of the bank
(King and Hongkong and Shanghai Banking Corporation, 1983). Mimetic isomorphism can further be seen in the bank’s crest. The images (refer to Figure 4-
4) appearing in the annual report of the bank’s logo in the 19th century, banknotes and official correspondence, were very colonial. The top part of the logo was the
British Royal coat of arms with a lion and a unicorn around a royal shield, with a crown on top. In the colonial context of Hong Kong, the organization’s activities as the chief financier for trade between Britain and China can be seen from the image of two ships and the people engaged in trade (Huppatz, 2005).
Figure 4-4 Logo of Hongkong and Shanghai Bank Corporation 1865 – 1982
Source: Hongkong and Shanghai Banking Corporation, Annual report 1997 cover
Chapter 4 Historical Context 89
Figure 4-5 An institutional view of the historical context of early HSBC
External pressures:
Politics
structure
Historical influences: Early HSBC
British empire, culture Chinese culture, Legislation
Internal pressures:
Founder’s influence
4.3.1 Founder’s influence – internal pressure
Any founder has a great impact on the structure and accounting practices of the organization he or she establishes. Their characteristics and practices often become institutionalized in the organization’s culture. This can clearly be seen in the case of
HSBC’s founder, Sir Thomas Sutherland. His Scottish background and experience in the Peninsular and Oriental Steam Navigation Company (P and O) had an impact on the bank’s operation and financial practices, as further discussed in section five.
Sir Thomas Sutherland was inspired by the news that a ‘local’ was working in
Bombay21 to set up a bank for local Hong Kong merchants. To be successful, a local bank would have to meet the diverse needs of the community and lure constituents
21 The Bank of China in Bombay was not welcomed by the local people in Hong Kong. They thought it was controlled from Bombay and not a local bank at all.
Chapter 4 Historical Context 90 from rival firms22. He produced a prospectus in English for a locally based bank that operated on ‘Scottish banking principles’23. The prospectus of the Hongkong and Shanghai Banking Company Limited (29th July 1864) stated that the establishment of a Mint in Hong Kong could provide an adequate supply of the proper currency. The bank could also become the exclusive medium for the transaction of monetary operations connected with trade and replace the
Compradoric system24 (Collis, 1965).
Hongkong and Shanghai Bank identified itself as a ‘local bank’, and ‘local’ refers not to Hong Kong alone but to Hong Kong, Shanghai and other trading ports in the region. Most of the banks at that time were branches of foreign banks, for example, the Chartered Mercantile Bank, the Chartered Bank of India, Australia and China, and the Comptoir d’Escompte (Muirhead, 1996). The prospectus attracted the support of a broad spectrum of Hong Kong interests, including American and Indian trading houses as well as European firms, and the initial capital was quickly taken up with the support of the leading firms25 in Hong Kong. The bank issued 20,000 shares of HK$250 and was governed by Colonial Regulations. It opened for business in Hong Kong on 3rd March 1865. It was founded to finance intra-regional trade among the open ports of China, Japan, and the Philippines, for which it would engage in financing trading facilities such as local steamship lines, docks, tug boats, and small industrial enterprises (Tsang, 2004).
22 This is seen in traditional rivalry between Jardine, Matheson and Co. and Dent and Co., between Russell and Co., and Augustine Heard and Co. 23 Scottish banking principles will be discussed in section 4.3.1. 24 Compradors acted as financial intermediaries who worked with the local bank, remittance offices, merchants and officials, operating especially between the bank and their Chinese counterparts. 25 Dent and Co., P&O SN Co., Borneo Co. Ltd., Smith Kennedy and Co., PF Cama and Co., P and A Camajee and Co., Augustine Heard and Co., John Burd and Co., Gilman and Co., Lyall, Still and Co., Siemssen and Co., D Sassoon, Sons and Co., and Fletcher and Co.
Chapter 4 Historical Context 91
Sir Thomas Sutherland launched the bank with capital of HK$2.5 million. It was supported by the sponsors, reflecting that they believed they had the support of the government of Hong Kong, and that the bank was not a mere exchange mechanism, but also a domestic bank serving the needs of the local community and assisting government in planning the reform of currency and financing the public services
(King and Hongkong and Shanghai Banking Corporation, 1983, 1987).
The provisional committee was formed comprising 15 members, including Sir
Thomas Sutherland and all the leading firms in Hong Kong except Jardine and
Matheson. The composition of the committee reflected the international nature of the merchants of the Treaty Ports. It included British, American, German, Danish,
Jewish and Indian members. Most of them belonged to firms established originally in Hong Kong (King and Hongkong and Shanghai Banking Corporation, 1987).
However, no local Chinese participated in the formation of the bank. It is hypothesized by the author that this is because of cultural differences and language barriers. With uncertainty in Hong Kong society, the founder of the bank had to imitate or emulate other successful organizations’ activities, systems or structures to enhance legitimacy (DiMaggio and Powell, 1983). This is a mimetic behaviour of the founder to adopt Scottish principles in HSBC. The influence of the founders is evident in the bank’s early financial reporting.
4.3.2 Early financial reporting of HSBC
At the beginning of the 19th century, accounting practices were somewhat unsystematic, with a variety of asset valuation methods and approaches to calculations of profits (Gordon and Gray, 1994) and no requirement to conform to a
Chapter 4 Historical Context 92 uniform format of financial reporting (Brief, 1966, Edwards, 1980, Kedslie, 1990,
Lee, 1979, Parker, 1991). Hong Kong was a British colony and did not have significant banking laws until the late 1960s. Major banks retained the traditions of
British overseas banks, traditions similar to those of royally chartered banks, while maintaining vital regional associations. HSBC was subjected, through the provisions of the Colonial Banking Regulations, to authorized regulatory supervision administered by the Governor of Hong Kong after consultation with or instructions from the Treasury through the Colonial Office. Although there was no specific banking law to govern the bank, it still had to comply with the English
Companies Acts, which have great impact on modern financial statement formats. It helped to maintain the economy as it became industrialized. The Acts which governed the bank’s accounting practices were considered to be coercive pressures in the institutional environment which stem from political influence and the problem of legitimacy (DiMaggio and Powell, 1983). These pressures increase the homogeneity of organizational structures in an institutional environment. Banks adopted similar structures and accounting practices as a result of coercive pressures.
For accounting purposes, most of the organizations in Hong Kong followed the instructions of the Joint Stock Companies Act of 1844, which required all companies to present a balance sheet to shareholders and an audit of their records and balance sheet. However, no legal prescription existed regarding the form of the balance sheet and there were inadequate disclosure and auditing provisions. The 1844 Act was eventually consolidated into the Joint Stock Companies Act 1856. It provided a standard form of balance sheet for the guidance of company directors and accountants (Chatfield, 1977, Chatfield and Vangermeerch, 1996).
Chapter 4 Historical Context 93
During that time, there was no accounting profession as such, as accounting practices were still being formulated. The first professional accountants’ organization26 was not formed until the 1850s. While regulation was limited, banks devised their own systems of accounting and the directors determined how much should be disclosed to shareholders. There were no professional accounting bodies in Hong Kong until the 1970s. The first local statutory accountancy body, the Hong
Kong Society of Accountants, was set up in Hong Kong in 1974 with the assistance of the Association of Chartered Certified Accountants. It was incorporated by the
Professional Accountants Ordinances (Chapter 50 of the Laws of Hong Kong) on 1
January 1973 and became the only statutory licensing profession (Hong Kong
Institute of Certified Public Accountants, 2005) .
The first annual report was produced as a report to its shareholders in 1865 on 12
February 1866 and an example of this is reproduced in Figure 4-6. It illustrates the way in which the bank accounted for its financial position and makes evident the reliance on auditors to monitor financial affairs, which was not required by any regulations and so was a legitimizing strategy. The balance sheet was a simple statement prepared for the general meeting of shareholders. The balance sheet simply listed all assets in order of realizability and liabilities in order of repayment priority. Therefore there were no classifications and no corresponding period figures. Furthermore, there were “no detailed notes to the accounts although the reserve fund was disclosed to be a separate statement from 1867 onwards” (Lee,
1983, p.83). The format of the balance sheet in 1865, with assets on the right,
26 The Society of Accountants in Edinburgh was chartered in 1854, but began in 1853, followed shortly after in Glasgow by the Institute of Accounts and Actuaries, chartered in March 1855 (Mathews and Perera, 1996).
Chapter 4 Historical Context 94 equities on the left and permanent capital at the top, is a distinctive feature of British balance sheet (Littleton and Zimmerman, 1962). During the 18th century bookkeeping began to be adapted to corporate and organizational needs.
During the early years, the bank had limited accounting and disclosure of information in its financial statements, due to generally accepted minimal legal requirements for bank accounting practice. HSBC was subject to the diminishing scope of British imperial banking policy, due to the continued economic independence of its Eastern constituents and its policy of retaining a significant percentage of its shares on the Eastern registers. Hong Kong itself did not develop significant banking laws until the 1960s. HSBC was incorporated under its own special ordinances27 authorized by the Treasury in Hong Kong. The special ordinances mainly focus on limited liability and the issuing of banknotes. They did not state a disclosure requirement. Therefore the bank’s accounts “have never been made public, they have always been audited” in the early 1860s (King, 1987, 35).
The semi-annual accounts were not a statement of the position of the bank on the date stated, because various branches of the bank closed their books on different days to enable the information to reach the Head Office. The auditors were concerned mostly about the dates at which these accounts were recorded, the time lag involved in their integration with Head Office accounts, the judgement of the status of non-performing loans, and the valuation of publicly quoted securities, a
“routine verification” process (Chatfield, 1977, 120). HSBC conformed with isomorphic pressures in order to emphasize its accountability to the public.
27 The Hongkong and Shanghai Bank Ordinance (no. 5 of 1866). It was modelled after the charter of the Asiatic Banking Corporation but with exceptions appropriate for Hong Kong.
Chapter 4 Historical Context 95
Figure 4-6 The first annual report of HSBC in 1865
HONGKONG & SHANGHAI BANKING COMPANY, LIMITED. Report of the Court of Directors General Meeting of Shareholders, TO BE HELD AT THE BANKING HOUSE OF THE COMPANY, WARDLEY HOUSE, HONG KONG, On Monday, the 12th of February, 1866.
To the Participator of the Hongkong & Shanghai Banking Co., Limited. GENTLEMEN – In accordance with the terms of the Deed of Settlement the Directors have now to submit to you their First Annual Report on the Positions of the Company’s affairs. The first call of $25 per Share was made on the first of January 1865, and the second call of $100 was due on the 31st of March; three payments were made with great promptness. The Company’s Offices at Hongkong & Shanghai were opened for the transaction of business in the month of April last, but were not in fair working order until the middle of May. The operations of the Bank to the 31st December have therefore extended over a period of less than eight months.
The following is the statement of accounts, which have been duly audited by the Honourable W.H. Rennie and Calab T. Smith, Esq.
Abstract Statement of Liabilities and Assets of the Hongkong and Shanghai Banking Company Limited, on the 31st December, 1865 LIABILITIES. ASSETS. Paid up Capital (3125 on 20,000 shares) $2,500,000.00 Cash Balances on hand and at Bankers $1,250,388.78 Deposits and Notes in circulations 3,384,876.62 Discounts, Loans, credits, &c., 3,144,446.75 Exchange acceptances, &c 5,731,434.62 Exchange Remittances, &c., 5,554,279.13 Branches and Agencies 1,548,219.18 Branches and Agencies, 3,393,430.75 Profit and Loss Account 255,055.93 Preliminary Expenses, 32,827.62 Sundries 7,069.07 Sundries 21,322.39 Total $13,396,655.42 $13,396,655.42
PROFIT AND LOSS ACCOUNT. To Dividend at the rate of 8% per annum, or By amount of Profit for the Eight months $133,200.00 $6.66 per share ended 31st December 1865, after deducting all expense and interest paid Amount carried to Reserve Fund 33,300.00 and due $225,055.93 Amount written off Preliminary Expenses, Bonus to constituents and Depositors, &c. 14,577.97 Rebate on Bills not due 31,696.66 Balance being undivided profits carried forward to next half year 12,261.00 225,055.93 We have examined and audited the above accounts and find them correct.
(signed) W.H. RENNIE, C.T. SMITH, Auditors.
Chapter 4 Historical Context 96
Lee (1983, 83) commented that “the profit statement was merely a report of recommended appropriations of figures, the balance sheet having been prepared excluding these appropriations”. For the profit and loss account, appropriations included dividends, amounts carried to the reserve fund, amounts written off for preliminary expenses, any bonus to constituents and depositors, and rebates on bills not due. Moreover, the Scots were the pioneers in developing the acceptance of deposits and the paying of interest. Traditional Scottish banking paid the same interest on both fixed and current deposit accounts. HSBC, on the other hand, paid 3% for three months, 5% for six months, and 6% for 12 months on fixed deposit and 2% on current deposit (King and Hongkong and Shanghai Banking Corporation, 1987). The bank deducted all the expenses and interest paid from the gross profit. However, the bank did not disclose the detail of the expenses on the profit and loss account for the year end.
Oliver suggested that organizations ‘respond to institutional pressures that affect them’
(1991, 145) by employing acquiescence, compromise, avoidance, defiance and manipulative strategies. HSBC responded to institutional pressures by resisting the expectation to conform. It only disclosed the minimum requirement of reporting in order to conceal its nonconformity, because ‘the appearance rather than conformity is often presumed to be sufficient for the attainment of legitimacy’ (Oliver, 1991, 155).
Its annual reports summarized the main preparatory works and disclosed a total figure for fixed assets; however, the bank never disclosed its tax figures (Lee, 1983). This may be due to the proprietary concept at that time. The bank is acting as an agent of the stockholders in paying the tax, which is really a tax on the income of the stockholders
Chapter 4 Historical Context 97
(Hendriksen and Breda, 1992, Littleton, 1966, Chow, 1942). The Proprietorship concept28 of recording was commonly used in the 19th century. The information provided in the financial statements was limited, with data summarized for use by owners and creditors who were assumed to have specialized knowledge of the business.
The valuation method of assets was considered to be of secondary importance because it was assumed that informed parties could make the necessary mathematical adjustments
(Chatfield and Vangermeerch, 1996). It was assumed that all net profit from all sources went directly to the owner, and so there was no distinction between operating income and other gains and losses, such as the revaluation of assets. The valuation of these will be discussed below in detail.
4.3.2.1 Valuation of assets and depreciation
Prior to 1889, the statutory requirements relating to depreciation and profits available for dividends were either uncertain or non-existent (Brief, 1966, Edwards, 1980,
Littleton, 1966, Yamey, 1960). Even British accounting texts ignored the depreciation problem faced by manufacturers (Lee, 1994, 493). The bank used historical cost for recording its assets during its early financial reporting (1865-1867) because it did not deal in real estate and its major activity was financing local merchants and the government (King, 1991, King and Hongkong and Shanghai Banking Corporation,
1987). Lee (1983) suggested that transfers of reserves appeared to be the method of accounting for the potential replacement of fixed assets, rather than formal depreciation
28 Proprietorship is considered to be the net value of the business to the owners. Revenues are increases in proprietorship and expenses are decreases under the proprietary theory. Net income accrues directly to the owners and represents an increase in the wealth of the proprietors. There is generally a personal relationship between the management of the business and the ownership (Hendriksen & Breda, 1992).
Chapter 4 Historical Context 98 policies, which were used from 1868 onwards. The bank adjusted the book values of assets by transferring the revalued amount to the reserve account; it did not have separate accounting for depreciation.
Organizations conform and adopt generally acceptable practices that meet the expectations of the key stakeholders in their environment. Through the adoption of generally acceptable accounting and financial practices, they receive stability and gain the social acceptance they require in order to survive (Meyer and Rowan, 1977, Meyer and Scott, 1992, Oliver, 1997). It was common to use replacement cost in 1875.
Therefore, the bank adopted the generally acceptable accounting practices such as replacement cost in the financial reporting from 1868 onwards, rather than historical cost.
Another issue of concern was the exchange rate valuation technique. The valuation of assets in relation to foreign exchange items was not disclosed in the financial reports.
The bank provided financing services for the trade between China and Western countries. The monetary system of China was complicated. Monetary silver in China took two forms: shaped ingots and dollar coins. Debts expressed in a unit of account, referred to in English as a ‘tael’, were expected to be paid in ‘monetary silver’. Debts expressed in a dollar unit of account were expected to be paid in dollar coins or dollar silver. Therefore the bank had to employ shroffs29 to handle and adjudicate cash payments (King and Hongkong and Shanghai Banking Corporation, 1987). Moreover,
29 Shroffs are money changers of a bank who test and evaluate coins in the Far East.
Chapter 4 Historical Context 99 loans issued by the bank to China were expressed in the original unit of account in which the loan was negotiated. However, from the financial reports of the bank, there were no exchange rates quoted with a specific time period.
4.3.2.2 Discount, loans and credit account
One of the influences of the Scottish Principle that can be seen in the financial statements was the introduction of cash credit. It was the forerunner of the modern overdraft. Cash credit accounts closely resembled what is today known as a line of credit. It was a popular lending device which offered advances to customers and helped attract new customers. The bank introduced “Discount, Loans, and Credits” accounts in its Statement of Liabilities and Assets in 1865. The British Banking system of the 19th century concentrated chiefly on the provision of short-term loans for the purposes of working capital rather than long-term loans for fixed capital investment (Boyns et al.,
1997, 53). Therefore, this item was placed under cash balances on hand. However, it did not include any provision for bad debts. The bank had from time to time written off losses or made allowances for bad or doubtful debts before stating net profits. From the financial statements, these loans and credits were mainly financed by deposits.
Therefore, a sound financial image was important to its ability to attract depositors and survive.
Apart from the cash credit accounts, the bank also had a “Branches and Agencies” account in the first two years following the foundation of the bank. Establishing branches countrywide which provided assessable banking services to customers is
Chapter 4 Historical Context 100 another of the Scottish Principles inherited from the founder of the bank. The bank commenced its operation simultaneously in Hong Kong and Shanghai and established a local Board of Directors there for more effectual operations. The cost of HK$3.39m for branches and agencies was included as an asset and HK$1.5m in liability on the balance sheet in 1865. This demonstrated the proprietary concept in early financial reporting by summing up of all the elements which constitute the wealth of the owner (Chatfield and
Vangermeerch, 1996, Godfrey et al., 2000, Hendriksen and Breda, 1992). The preliminary expense was also included as an asset for the first two years of establishment. These costs were on the balance sheet until 1868, when they were run down.
4.3.2.3 Contingent fund account
The influence of the founders on financial reporting could further be seen from the contingent fund account. Normal losses could be met from net profits before publication; however, in years of extraordinary losses, the Board of Directors had the power of choosing accounting procedures. For example, the published accounts in 1872 showed an allocation of profits to a contingency account recommended at the General
Meeting (King and Hongkong and Shanghai Banking Corporation, 1987). There were subsequent transfers which took place before disclosure of profits. According to the
1872 minutes of the bank, the Board of Directors had a choice between writing off the losses and presenting a low figure in the profit and loss account or recommending the allocation of net profits to a contingency fund at the General Meeting. The Bank chose the policy of meeting losses as they arose and declared the situation to the shareholders.
Chapter 4 Historical Context 101
However, the bank changed its policy in 1874. This was due to the public’s awareness of the profitability of the bank. There was a possible loss on the non-repayment of a loan to the Indo-Chinese Sugar Company Ltd. Whether a loss has occurred or is contingent depends on the directors’ expectation. The Board of Directors was more conservative and allocated $781,000 to a contingency fund even though the estimated loss was only $680,000. The bank also warned the shareholders that a possible loss of
$275,000 might be suffered.
4. 4 External pressure
Financial reporting became more important for HSBC because of its role as a note- issuing bank in Hong Kong and also to attract more investors and depositors. Under the
HSBC’s special ordinances, shareholders were liable on the winding up of the company to the extent of their subscribed capital and an equal additional amount. This double liability requirement was for the protection of the bank’s banknote holders. The
Treasurer of Hong Kong in 1857, James Wilson, explained that “banks are not only trustees for money deposited with them, but are also dealers in money deposited, and the money with which they deal is to a great extent the property of others” (HSBC,
1857, 211).
The formation of associations of professional accountants began in Scotland during the
1850s and in England from the 1870s (Mathews and Perera, 1996). Hong Kong, during that period, did not have its own Banking Ordinance or accounting regulations. Most organizations just followed what had been done in England (King and Hongkong and
Chapter 4 Historical Context 102
Shanghai Banking Corporation, 1987, Mathews and Perera, 1996). HSBC retained the traditions of a British overseas bank while maintaining the regional associations which were the key to continued success. The bank was incorporated under the Colonial
Banking Regulations. HSBC, therefore, conformed to and adopted generally acceptable practices that met the expectations of the key stakeholders in their environment. This increased its legitimacy (Covaleski and Dirsmith, 1988, Scott, 1987) and most importantly gained the acceptance required to survive (Meyer and Rowan, 1977, Meyer and Scott, 1992, Oliver, 1997)
4.4.1 Criticisms of the financial arrangement of the HSBC
Lending in HSBC was based on the security of bank shares. By lending against shares,
HSBC might give a false sense of liquidity to the economy, and the projected enterprises required fixed capital financing and the merchants required funds for carrying on their normal business. The merchants invested their trading funds in fixed capital, turning to the bank for liquidity and presenting their shares as security. This practice would become a disaster if the borrowing companies failed. On the other hand, if the bank did not accommodate its constituents, it was not fulfilling its promised role.
Although it was risky to lend against shares, this a legitimate banking practice under the
General Companies Ordinance (King and Hongkong and Shanghai Banking
Corporation, 1987). Therefore, sound and reliable financial reporting is important for a bank to survive.
Chapter 4 Historical Context 103
From its earliest days, the bank had a very close relationship with the Government of
Hong Kong. In May 1872, the bank became the Government’s banker as it held
HK$342,285, which was more than one third of total Government fixed deposits, and, most important of all, it handled the current monies with the current account. The close connections of the bank with the government led to informal discussions which are not in the public records. They were facilitated by the presence of the Bank directors and officers on the Legislative Council, including Sir Thomas Sutherland and the Chief
Manager, James Greig30. The acting Auditor General commented in 1889 that the amount of gratuitous assistance received from the Bank was very considerable (King and Hongkong and Shanghai Banking Corporation, 1987, 161). The Board of Directors was from time to time called upon to make policy decisions on proposals on the issue in
China, and also on publicly issued loans. This supports the argument that the bank had successfully established its creditability and maintained an acceptable image to society for its survival. For example, the bank made practical proposals to help the Post
Office’s money order remittances in a way that was beneficial both to the Post Office and to the public. The bank earned a reputation for cooperation and a number of new investors bought shares in it.
Because of its being a note-issuing bank in Hong Kong and the close relationship with the government, HSBC’s financial statements were of concern to the public. In October
30 James Greig, the Chief Manager, joined the bank in late 1869. He was a former manager of the Asiatic Bank.
Chapter 4 Historical Context 104
1874, James Greig committed the Bank to a Foochow loan31 of £627,615 at the agreed but arbitrary exchange rate of 2 million taels, denominated in sterling. It was arranged for a predictable return on the bonds in terms of that currency. The bank did not issue the sterling-denominated bonds to the public in Hong Kong and Shanghai until June
1875. The bank had immediately advanced ‘on account’ 60,000 taels which were not included in the terms of the contract. This may have been due to pressure from the
Chinese Government (Born, 1983, King, 1983a, King and Hongkong and Shanghai
Banking Corporation, 1987, Liu, 1979). The full amount of the loan to the Chinese authorities was made on 19 December 1874. The total account was included in the
December 1874 accounts under ‘discounts, loans and credits’. HSBC had no guarantee that the bonds issued to the Hong Kong Government for public issue would be taken up.
The directors informed shareholders, without being asked, that the amount had been taken from the Reserve Fund. For HSBC, the purposes of the reserve fund are specifically stated to include equalization of dividends under Articles 151-58 of the
Deed of Settlement. This method was widely used by some leading banks in Hong
Kong32.
Organizations adopt institutionally acceptable practices to legitimate their existence
(Covaleski and Dirsmith, 1988) in order to survive. Therefore, organizations within a
31 The 1874 Loan was a “sterling loan”, which meant that sterling was the unit of account in which amounts would be calculated, although the actual transactions were performed in the local currencies at an agreed rate of exchange. The loan was payable to the Chinese in Foochow in taels. The amount due for repayment was repayable in taels at the rate of the day for sterling drafts on London although the loan was defined in sterling.
32 The reserve fund was authorized for the purpose of “equalizing dividends” by the Bank of Hindustan, China, and Japan under the Acts of 1857 and 1858 (Art. 122 of the deed of Settlement).
Chapter 4 Historical Context 105 particular field assume similar structures and practices. This is referred to as institutional isomorphism. Such mimic forces can be seen from the reserve fund account of HSBC. There was no limitation on the amount of current profits which could be set aside into a separate fund. Therefore, the handling of the reserve fund would be entirely at the discretion of the Board of Directors, who would decide when the fund sufficiently large to meet possible losses, and who would also be permitted to propose paying out any estimated ‘surplus’ in dividends. Moreover, this reserve fund was not considered part of the bank’s capital for purposes of legal analysis or compliance with the provisions of the ordinance, for example the limiting of the note issue to paid-up capital. If the losses were met by withdrawals from the reserve fund, the shareholders’ fund would decrease and this would affect both the credit of the bank and the share price.
Moreover, the bank recorded that the profit on the loan amounted to approximately
HK$125,000 ‘up front’. It was calculated based on the difference between the rates at which the funds were made to China and the bonds sold to the public. The bank credited a high proportion of the profits of the loan to the end of 1874 in the Profit and
Loss Account. This incident raised questions about the profitability and accountability of the bank’s accounts to the shareholders. Public awareness of the accounting procedures was reflected in China Punch33. Figure 4-7 is the New Year’s cartoon about the bank that it published in 1875. In the cartoon, Father Time is shown emerging from the gloom of 1874 bringing in the New Year, a bag of silver dollars with legs and
33 China Punch was a magazine at that time.
Chapter 4 Historical Context 106 clearly marked ‘1875 Loan…£675,645’ (King and Hongkong and Shanghai Banking
Corporation, 1987, 205). The shareholders insisted on an authorized inspection and exposition of the real state of the bank’s accounts.
Figure 4-7 China Punch New Year’s cartoon
Furthermore, there was no separate provision explicitly made to account for the bank’s expenses and profit from handling the loan. The way the bank calculated its profit from the loan transaction included the amounts received by the bank in interest on the bonds and the profit made by reselling later at par (King, 1983a). However, it should be considered a return on the bank’s investments . The bank “recognized” the profit at the time the event occurred. However, there was uncertainty about the outcome. This brings out the recognition problem of profit. There was no definition of “realized profits” and no accounting standard in the 19th century. This did not occur until the 20th century (Gordon and Gray, 1994, Hein, 1978). The Joint Stock Companies Act of 1844
Chapter 4 Historical Context 107 made no reference to the statement of profit and loss account. It was not until the
Companies Act of 1929 that it was required that of a profit and loss account be laid before the company in a general meeting (Hein, 1978). Therefore, the bank recorded the profits of the loan to Profit and Loss in 1874 in order to pay out a dividend for the year and project a sound image of its financial position. The Chairman explained at the
General Meeting that this was due to the poor half-year’s result, and without the China
Loan, there would be no profit available. This result can be seen from Figure 4-8. The directors explained the situation from the proprietary viewpoint, that is, regarding the assets and liability as those of the proprietor, with the potential use of the net worth is unrestricted (Godfrey et al., 2000).
Figure 4-8 Abstract of Assets and liabilities and Profit and Loss 1867 - 1874 Assets and liabilities, 1867 - 1874 (in millions of HK dollars) 1865 1866 1867 1868 1869 1870 1871 1872 1873 1874 1875 1876 1877 Assets Cash on hand and with banks 1.25 1.94 3.95 4.23 4.25 10.18 9.35 8.1 11.26 8.55 4.36 4.45 5.72 Discounts, loans, credits 3.14 4.07 3.37 4.38 4.76 8.11 7.65 11.03 9.84 9.76 9.25 8.67 10.34 Exchange remittances 5.55 9.20 13.29 12 17.98 16.67 21.31 32.22 26.95 21.87 18.15 28.92 34.01 Branches and agencies 3.39 Preliminary expenses 0.03 0.02 Government securities 0.24 0.72 0.94 2.95 2.04 2.16 2.82 2.48 2.55 0.93 23.4 Other 0.11 0.12 0.13 0.14 0.15 0.16 0.26 0.32 Buildings 0.06 0.23 0.22 0.21 Dead stock 0.01 0.03 0.09 0.1 0.1 Total Assets = liabilities 13.37 15.32 20.96 21.45 28.07 38.05 40.5 53.67 51.14 42.91 34.63 43.29 52.71
Liabilities Paid-up capital 2.5 2.5 2.5 2.5 2.5 2.5 2.5 5 5 5 5 5 5 + Paid up (new shares) 0.39 0.5 0.5 1 1.5 2 +Marine Insurance Account 0.03 0.05 0.07 0.07 + Reserve Fund 0.1 0.25 0.5 0.7 0.8 0.9 1 1 0.1 0.1 0.2 0.65 = Shareholders' funds 2.5 2.99 3.25 3.5 4.2 1.8 5.4 6 6 5.13 5.15 5.27 5.72 Deposits and notes 3.38 4.13 6.28 7.06 7.81 11.11 12.58 16.07 18.77 19.8 13.41 13.07 22.36 of which :banknotes 0.8 0.93 1.22 1.11 1.76 1.71 1.52 2.37 1.96 2.24 1.88 1.31 2.04 Exchange acceptances 5.73 7.86 11.04 10.42 15.68 21.67 22.12 31.26 26.13 17.86 15.74 24.44 24.08 Branches and agencies 1.55 Profit and loss 0.39 0.46 0.37 0.46 0.4 0.34 0.24 0.12 0.34 0.5 0.55 Profit and Loss By amount from (in thousands of dollars) Reserve Fund 675 By balance of undivided profits 0 45.7 14.2 70.7 116.8 99.4 31.3 122.8 36.8 7 106 38.1 14 By amount of profits 193.4 278.3 368.1 382.6 249.5 361.7 367 206.4 199.7 112.7 228.1 460.7 535 =Total funds to be allocated 193.4 324 382.3 453.2 366.3 461.1 398.3 329.2 236.3 794.8 334.1 498.8 549 To preliminary expenses 6.4 5 10 268.6
108
To bonus to customers 8.2 To Contingency Fund 781 145 To dividend 132.2 180 180 180 210 160 270 300 200 0 150 177.78 177.78 To directors' remuneration 28 10 10 10 10 10 10 10 10.7 20 10 10 To reserves 33.3 75 125 200 100 0 100 0 0 0 0 300 350 To balance carried forward 12.3 35.9 57.3 63.2 46.3 22.6 18.3 19.2 26.3 3.1 19.1 11 11.2 Reserve Fund: new balance 375 700 800 800 1000 1000 1000 100 100 500 1000
109 Chapter 4 Historical Context 110
The shareholders did not raise the loan as a point of significance at the annual meetings until 1875 because of their trust in the bank. They then criticized the directors for knowing about the problems and withholding information. The directors defended themselves saying that the Chairman had informed the shareholders in a general way and raised the question of the auditors’ inability to detect the unauthorized investments.
The bank was aware of these and other criticisms and sought to correct the impression at every opportunity. The bank’s response was to present itself as financially reliable. As a result, a London Committee was set up to examine and inspect all the bill schedules and the problem of lending on the ultimate security of Bank shares. An internal inspection system was set up beyond the scrutiny of managers. Although no provisions were made at that time for auditing the accounts on which the statements were based, or the statements themselves, all the bank’s accounts were to be audited under the terms of the ordinance. It was not until 1879 that banking companies were required to submit their accounts to an annual audit, and report on both the accounts and the balance sheet at a general meeting. Auditors were required to sign every balance sheet submitted to the annual meeting of the members of the company (Hein, 1978, 137). The financial reports were signed by the Directors as well as by the Accountant. The bank also appointed a
Chief Accountant to act as a permanent inspector. King and Hongkong and Shanghai
Banking Corporation (1987, 206-207) commented it was “partly self initiated, partly forced by events and outside pressures”. Claims to financial reliability rested on the provision of a balance sheet audited by public accountants, the existence of a reliable accounting system and strict monitoring of lending procedures. The quick response of
HSBC was to present itself as a financially reliable organization. Claims to financial
Chapter 4 Historical Context 111 reliability primarily rested on the existence of a reliable accounting system, including a proper method of profit realizability and a contingency account, more disclosure to the shareholders and audit by a reputable firm of public accountants.
In 1875, the North-China Herald commented that “the report of the Hongkong and
Shanghai Bank seems to have very generally re-assured shareholders as to the soundness of its position” (North China Herald, 1875). HSBC disclosed the losses which had swept away the Reserve Fund and prepared a set of financial statements for inspection by the shareholders. The Chairman of HSBC emphasized its accountability to the public and announced at the February meeting that the bank had full confidence in Hong Kong and the worst has been declared at last. The total amount of deposits rose gradually and the exchange remittance were almost doubled by 1876. This shows that the depositors and investors had faith and confidence in the bank again.
Institutional theory is used as a filter to provide possible explanations of the way HSBC presented its early financial statements. The institutional framework relates to the resilient aspects of social structure within accounting practice by emphasizing the influences of the institutions both of society and of the organization. It views organizations as operating within taken-for-granted assumptions about what constitutes acceptable economic behaviour (Oliver, 1997). Institutional theory explained how HSBC interacted with the institutional environment of the commercial sector and government.
The social expectations of HSBC were incorporated and reflected in their organizational practices (Dillard et al., 2004, Martinez, 1999). HSBC, under the pressures of society, had to conform with public expectation about its financial reporting. Therefore, the bank
Chapter 4 Historical Context 112 responded to institutional pressures by disclosing more accounting information which included its profit realization method and contingency account. Mezias (1990) concluded that changes in the institutional environment can drive changes in the financial reporting practices of individual firms. The bank used financial statements as a legitimizing strategy to establish its creditability, and successfully increased its survival capabilities. The long-term survival of the bank was mainly due to its ability to gain the trust of local investors and the Government of Hong Kong, particularly in relation to financial and accounting practices. Financial statements helped to assure the public of the Bank’s credentials and secure a legitimate status for note issuing for the Hong Kong
Government and its financing operations. They acted as a powerful tool to enhance the bank’s corporate image and therefore its survival, growth and profitability.
4. 5 Expansion of the bank
The Chinese Civil War broke out in 1946 and ended in 1949, followed by the formation of the People’s Republic of China. Hong Kong’s growth gained momentum with the establishment of the communist regime in China in 1949, as it became the only contact between China and the non-communist world (Szczepanik, 1958). Towards the end of the 19th century, “Hong Kong’s position as a major port in world trade and as a terminus for China’s coastal trade was firmly established” (Chiu, 1973, 35). Hong Kong’s trans- shipment facilities and commercial services provided a link for the trade between China and the rest of world because transportation in China at that time was practically undeveloped. The political climate of China was tense and the government of China blocked most communication between China and the outside world. An efficient link
Chapter 4 Historical Context 113 between its coastal and inland waterways and world shipping routes was vital to its economic development (Johnson, 2000).
Several factors contributed to HSBC’s success. Hong Kong benefited not only from the existence of trade ties, but also from a powerful injection of low-cost labour from the neighbouring Guangdong province in China. Because of the Chinese Civil War, industrialists from mainland China came to Hong Kong and brought with them not only skill and knowledge but money as well. They built many plants and factories with new machinery to manufacture goods such as plastics and textiles for export. Many Chinese workers flooded over the border in 1949 and came to settle in Hong Kong during the
Chinese Civil War. The first group of people from the mainland to settle in Hong Kong were mostly rich businessmen from Shangahai who rushed in before the Second World
War. HSBC benefited from these new settlers’ cash for investment in Hong Kong and a place to deposit their money. Those who tried to escape from the Civil War were mostly unskilled and willing to accept low wages. Hong Kong therefore employed a lot of
Chinese workers to manufacture industrial and consumer goods. By 1961, nearly half of the workforce was employed in manufacturing, which comprised a quarter of Hong
Kong’s GDP (The Economist, 1998a).
Hong Kong soon developed into an industrial centre in the mid-20th Century.
Industrialization during the 1950s was narrowly based, being dominated by labour- intensive manufactured exports, mostly textiles and clothing. During those years, Hong
Kong benefited from trade with the Western world, as Western countries sustained growth and favoured trade liberalization. At the same time, the political turmoil in
Chapter 4 Historical Context 114
Southeast Asia, particularly Thailand and Indonesia, brought a further flow of capital funds into Hong Kong (Auyeung, 1997).
HSBC began to emerge as an international bank and laid the foundations of today’s
HSBC Group when it acquired the Mercantile Bank and the British Bank of the Middle
East in 1959. The diagram below (Figure 4-9) is the advertisement from the 1959 announcement of HSBC’s acquisition of the banks. The heading of this advertisement is
“Three doors in London opening on the East”, with a drawing of a globe and three doors on it. The slogan is
“Three banks have merged. Separately, they have large assets, a fine
tradition and a wealth of experience. United, they offer a
comprehensive service in all matters affecting business with the East.”
The advertisement ended with “Branches throughout the World” (HSBC
Holdings plc, 2003, 23). This symbolized that the bank still saw itself as a
British bank as it included itself as one of the doors in London. It was a business hub between the East and the West.
Chapter 4 Historical Context 115
Figure 4-9 An advertisement in 1959 announcing Hongkong and Shanghai Banking Corporation’s acquisition of Mercantile Bank Ltd and The British Bank of the Middle East
Source: HSBC Holdings plc, 2003 ,23
During the 1970s, HSBC played an important role in Hutchison Whampoa. Hutchison
Whampoa was part of HSBC group and involved in its complex financial arrangements.
Hutchison Whampoa was the first traditional Hong Kong trading company to be controlled by the Chinese (Johnson, 2000). The bank functioned as an alternative to
Chapter 4 Historical Context 116
Jardine Matheson in providing financing support to Chinese merchants. It demonstrates that the bank wanted to have a closer relationship with the local Chinese rather than the
British. This detail of the event will be discussed in section 6.1.4.
HSBC had played a particularly important part in the rise in prosperity during the mid-
1970s. The years 1976-82 saw the flowering of a large middle class and a new breed of local entrepreneur. This development was linked to the growth both of Western banking and Chinese industry. The sharp rise in productivity in 1976 had shown that, of nearly
800,000 registered factory workers, only 8% were working for foreign-backed concerns.
The rest were employed by indigenous industrialists (Patrikeeff, 1990).
HSBC dominated the financial sector of Hong Kong throughout 1965 – 1973. Its share of loans and advances did erode during the 1960s but it remained the outstanding leader in the market. The bank accounted for 46 % of total bank advances at the end of 1958, but the share fell by 10 percentage points over the next two years, reaching 34% by the end of 1961. This reflected a declining share in commercial finance when trade with the
UK receded while trade with China and the USA accelerated (Schenk, 2004b).
After 1973, economic growth in Western countries slowed down rapidly because of the
Cold War, accompanied by an increase in protectionism. At the same time competition from newly industrializing countries, such as Japan, West Germany, Taiwan and South
Korea intensified. Hong Kong had maintained its competitiveness in the world market by entering into a new phase of broad-based development (Chen, 1984). With the help of foreign direct investment, it successfully achieved diversification in its range of industrial products, particularly watches and clocks, electrical appliances and chemicals. Apart
Chapter 4 Historical Context 117 from diversification in the manufacturing sector, Hong Kong had fast emerged as a major financial centre for the Asian Pacific region. According to Chen (1984), the contribution of financial services to GDP (26%) exceeded that of manufacturing (25%) in 1980. A survey done by Jao (1979), indicated that there were about 188 foreign banks transacting banking business through fully licensed branches, representative offices, or registered deposit-taking subsidiaries in early 1978.
HSBC extended its services in mainland China from the late 1970s following the introduction of Deng Xiaoping’s34 ‘open door’ policy35 and in support of the country’s international trade. Hong Kong’s entrepôt trade revived and many multinational corporations took advantage of Hong Kong’s modern infrastructure and strategic location to establish their regional headquarters in Hong Kong (Auyeung, 1997). HSBC became the first foreign bank since 1949 granted a banking licence in China, with a full branch office in Shenzhen. Previously, the HSBC building in Shanghai had been handed over to the Chinese government due to political reasons in 1949. The bank was forced to scale down its operations in Shanghai and move to a rented office nearby. Even after the take- over of Hong Kong in 1997, it was still one of the first international banks to have permission to conduct Renminbi36 business in China.
34 Deng Xiaoping was China's paramount leader, Vice-Chairman of the Central Committee, Vice-Premier of the State Council, Vice-Chairman of the Military Commission and Chief of the General Staff of the People's Liberation Army. 35 Open-door policy referred to the setting up of Special Economic Zones in southern China with tax incentives and cutting back bureaucratic interference and stifling rules to attract foreign capital and investment which in turn contributed to the modernization of both production processes and the Chinese product mix. Chinese contribute raw materials, infrastructure and cheap labour and foreign partners supplied advanced technology and production processes. The best known Special Economic Zones were Hong Kong, Shenzhen and Xiamen. 36 Renminbi is the currency used in China.
Chapter 4 Historical Context 118
4. 6 Banking sector in Hong Kong
There were 138 licensed banks, 31 restricted-licence banks, and 33 deposit-taking companies in 2006. Among the total of 202 authorized institutions, 181 are beneficially owned by interests from 30 countries and there are 84 local representative offices of overseas banks in Hong Kong (Hong Kong Special Administrative Region, 2007).
Hong Kong’s banking sector was conspicuous for the absence of any prudential supervision before 1964 because Hong Kong did not have its own Banking Ordinance and it followed almost all of the regulations of the British. It can be described as ‘free banking’ or ‘wildcat banking’, depending on the view point of the observer (Jao, 2003).
The first Banking Ordinance of 1948 adopted from the British was primitive by present- day standards. It provided only for the licensing of banks, publication of bank statements and examination of bank books. There was no supervisory body or prudential measures such as liquidity and capital adequacy requirements. The Hong Kong Government revised the Banking Ordinance in 1964 after a bank run in 1961. This revised Banking
Ordinance included a requirement for a liquidity of 25%, a minimum paid-up capital and limitations on loans and investments (Jao, 1974, 2003).
Competition among banks is very intense. There was another banking crisis in Hong
Kong before 1965. The government imposed a moratorium on bank licences in 1966
(Hsu, 1986, Tai, 1986). This denied newcomers entry to the Hong Kong banking market.
It was then relaxed in March 1978. This initiated a large influx of foreign banks and the
Government had to reimpose the moratorium (Tai, 1986). This is further discussed in
Chapter five.
Chapter 4 Historical Context 119
In 1981, the government created the ‘three-tier financial system’ which placed deposit- taking institutions into three categories: Licensed Banks, Licensed Deposit-Taking
Companies and Registered Deposit-Taking Companies (Chiu and Choi, 1994, Hong
Kong Institute of Bankers, 1999). It constituted a market barrier for the establishment of new banks. Financial institutions which did not want to be under the control of Interest
Rate Rules (IRR) in order to offer higher interest rates had to be registered as a Licensed
Deposit-Taking Company or Registered Deposit-Taking Company. However, there were constraints about the minimum denominations and terms to maturity of deposits. Major banks inside the Hong Kong Association of Bankers (HKAB) were controlled by the IRR and other financial institutions outside the HKAB were not allowed to explore the market of small depositors and retail banking (Chan, 2002). Under the IRR, local small to medium banks were not allowed to offer more competitive interest rates than the
British banks. Because of their long history in Hong Kong and notes-issuing status, the
HSBC and Standard Chartered banks naturally gained the confidence of depositors and investors and occupied a large share of the banking market of banking in Hong Kong.
The interests of HSBC were protected by the three-tier system because it set barriers against foreign banks entering the market. Foreign incorporated banks that obtained their licenses after 1978 were prohibited from opening branches other than their single main offices. For new foreign banks to establish in Hong Kong, they had to arrange join- ventures with the local Chinese small to medium banks or register as deposit-taking companies to counter the protective strategies in Hong Kong. Such foreign banks were welcomed by the Chinese banks because of their need for capital to compete with the
British banks.
Chapter 4 Historical Context 120
Licensed banks dominated the banking system in Hong Kong during the 1990s, holding
98% of deposits and making 93% of loans (Hong Kong Monetary Authority, 1999).
Foreign banks account for two thirds of deposit-taking financial institutions and over half their assets. HSBC and the Bank of China, which incorporated outside Hong Kong, own the bulk of foreign bank assets.
During 1982-86, a crisis in confidence over its future after 1997 engulfed Hong Kong. It resulted in a collapse of the assets markets, especially to the property market (Barnes and
Marron, 1987). In response, a team from the Bank of England was commissioned in
1984 to study the issue, and a new Banking Ordinance came into force in 1986.
The Three-Tier Banking System (Values in HK$) Licensed Banks Restricted- Deposit-Taking License Banks Companies (RLBs) (DTCs) Minimum capital 150m for local banks 100m 25m Minimum deposit of an account No 0.5m 0.10m Maturity restrictions (months) on No No Not<3 months deposits Interest rate restrictions Need to observe the No No interest rate rule of the HKAM (Adopted from Ho et al., 1995, 40)
A Code of Banking Practice was issued in 1988 and a minimum capital adequacy requirement was imposed. Hong Kong was well positioned to meet the 8% capital adequacy ratio when the Basel Accord37 was announced. Actually Hong Kong met the
8% criterion in 1990, which was two years ahead of the target date of 1992. According to the annual report of HKMA in 1998, the average capital adequacy ratio of the banking
37 Basel Accord refers to the recommendations on banking laws and regulations issued by the Basel Committee on banking supervision.
Chapter 4 Historical Context 121 system was as high as 18.6% at the end of 1998 when Hong Kong was in a deep recession because of the Asian crisis (Jao, 1988).
The deregulation can be seen in the form of an interest rate cartel. The interest rate cartel
(Interest Rate Rules (IRR)) was formed by the Hong Kong Exchange Banks’ Association in the early 1960s to stop the interest rate war during the years of free banking (Jao,
2003, Kwan, 2003, Kwan and Lui, 2002). Banks were classified into different categories under this arrangement. The largest international banks, such as HSBC and Standard
Chartered bank, offered the lowest rates while the smallest local banks offered the highest rates on term deposits. The rate on savings deposits was uniform for all banks
(Chan, 2002, Jao, 1974, Kwan and Lui, 2002). IRR was used as a stabilizing device for preventing severe competition. As a result of this cartel, the extra interest earned was estimated at about 1% of the GDP of Hong Kong (Chan and Khoo, 1998). This extra interest earned came mainly from demand deposits and savings deposits. The benefit was therefore directly proportionate to the bank’s ability to attract deposits. HSBC was the largest retail group and occupied about 35% of total deposits in 1994 when HKMA was first established. This means that HSBC had monopolistic power on the extra interest earned. Although the IRR was imposed by the HKAB, it was chaired by HSBC and the Standard Chartered Bank alternatively every year. This demonstrates the coercive influence of the bank over the banking and financial sector in Hong Kong.
The IRR aroused the public’s consciousness of the cartel’s defects and strongly attacked the cartel for exploiting depositors and extracting abnormal profits for the banks (Kwan,
2003, Kwan and Lui, 2002). It forced the HKAB to agree to a partial deregulation of
Chapter 4 Historical Context 122 interest rates on term deposits of more than one week during 1994-1995. The IRR was phased out completely in 2000 after the sovereignty of Hong Kong had been returned to
China in 1997. As a result of the removal of deposit rate restrictions, profits for banks declined, as did bank shareholders’ wealth because the deposit to assets ratio in Hong
Kong was generally higher than other countries (Kwan, 2003).
Furthermore, deposit insurance was introduced in 2004 under the Deposit Protection
Scheme Ordinance (Chu, 2000, The Hong Kong Deposit Protection Board, 2005). The proposal was rejected and opposed by major banks in Hong Kong. They argued that it would remove depositors’ incentives to discriminate between prudently managed depository institutions and risky ones, and that the problematic institutions would expand rapidly by offering higher deposit interest rates.
4.6.1 Importance of HSBC in the history of the currency system in Hong Kong
The Colony’s own currency system was developed in the 1840s. There was no local currency existing for circulation when Hong Kong was first established as a free trading port in 1841. Copper, bronze or iron were used as cash for day-to-day transactions, and uncoined silver ingots were used by larger businesses for transactions. Spanish and
Mexican silver dollars were used for international trade (Hong Kong Special
Administration Region, 1997, Wang, 1997). The modern banking industry began to take shape in Hong Kong when the first bank, the Oriental Banking Corporation, was established by some British merchants with its headquarters in India in 1845. It was recognized by the Hong Kong Government in 1857 as the first bank in Hong Kong to issue banknotes from 1845 (Chinnery, 1852, Hong Kong Monetary Authority, 2004a,
Chapter 4 Historical Context 123
McGuire, 2004). Only the Royal Chartered banks, or banks incorporated under special legislation of the Legislative Council had been authorized to issue notes. The reason was that the government wanted to prevent people from suffering in the event of a bank collapse.
The bank was incorporated by a Colonial Government ordinance and was subjected through the provisions of the Colonial Banking Regulations to authorized regulatory supervision administrated by the Governor of Hong Kong and the Treasury through the
Colonial Office (King and Hongkong and Shanghai Banking Corporation, 1987, 12).
The Treasury was concerned about the colonial note issue because Hong Kong did not have an overall banking policy in the early 1800s. People in Hong Kong preferred banknotes to coinage because there was no local mint to control the quality and quantity of coinage. However, the situation was not understood in London and the government of
Hong Kong refused to issue its own notes (King and Hongkong and Shanghai Banking
Corporation, 1987). The Hong Kong Government concluded that the bank had done the job of note-issuing and so why bother to take on a complex, time-consuming and labour- intensive task.
Other banks began to be established and issued their own currencies. Later in 1853, the two most influential banks were established in Hong Kong. The first was the Chartered
Mercantile Bank of India, London and China38. It was incorporated by British Royal
Charter and granted a “special permit” to distribute recognized currency. The second was the Chartered Mercantile Bank of India, Australia and China (Chartered Standard
38 The Chartered Mercantile Bank of India, London and China was acquired by HSBC in 1959.
Chapter 4 Historical Context 124
Bank). In 1862, it was recognized by the Hong Kong Government as a note-issuing bank. Other banks were established and issued bank notes. However, such notes were not accepted by the Treasury for payment of government taxes but were still acceptable for circulation. In 1872, HSBC was given permission by the Hong Kong Government to officially issue $1 banknotes. In 1884, the Oriental Bank went into liquidation, leaving
HSBC as the sole issuer of bank notes. The failure of the Oriental bank was mainly due to the decline in value of silver with the discovery of rich silver ores in Nevada, which flooded America with silver. The value of silver then fell dramatically when large quantities of silver were thrown onto the market. In 1891, the first Chinese note-issuing bank, National Bank of China, was established. However, it was never recognized by the
Hong Kong Government and closed down after four years because of the changing government policy (Cheng, 1994). Although Hong Kong was claimed to be a free trading port, the issue of money was tightened by the British Government. They had absolute power over the issue of banknotes.
HSBC also had a close relationship with the British Government in three ways. Firstly, the bank had an arrangement with the British Government to manage the Treasure Chest, the fund from which payments were made to persons in the British government’s employ during the 1800s. Secondly, it was also chosen as the medium for raising loans on the
European market by the Mainland Chinese government. Thirdly, Robert Hart of the
British consular service, who was in charge of the collection of customs at the Treaty
Ports of Hong Kong, used HSBC. The bank won the confidence of the imperial government and subsequently was asked to manage a series of railway loans because of its close relationship with the British Government.
Chapter 4 Historical Context 125
According to the British Monetary Authority (BMA), to establish a bank and issue bank notes a bank had to first apply to the BMA. It was then approved by the BMA or the
Imperial Treasury Colonial Office to British Imperial Treasury, and followed the
Colonial Banking Regulations. Bank notes were not legal money because they were just evidence of a liability owed to the shareholders, and therefore they were only called
“Hong Kong Dollars”. It was not until December 1935, when Hong Kong switched from a silver standard to sterling exchange standard, that bank notes became legal tender.
The silver standard was the basis of Hong Kong’s monetary system until 1935. With the establishment of the One-Dollar Currency Note Ordinance of 1935, the Government declared the Hong Kong Dollar to be the local monetary unit and switched from the silver standard to sterling exchange standard. Hong Kong’s monetary system then formed gradually. Under the Currency Ordinance 1935, banknotes in denominations of
$5 and above were issued by the three authorized local banks, namely the Mercantile
Bank of India Limited, the Chartered Bank of India, Australia and China (which is the forerunner of the present-day Standard Chartered Bank), and the Hongkong and
Shanghai Banking Corporation. They were all declared legal tender.
After the reform of monetary policy by the Hong Kong Government, a number of banks were established and issued notes. Some of them have been recognized by the government but some were not. This is because most of the banks were small enterprises and did not have enough capital support. Among all of the note-issuing banks, some went bankrupt, some withdrew voluntarily or merged with others, and only two of them remained by 1978. Most of the banks were established by foreign merchants and were
Chapter 4 Historical Context 126 branches or subsidiaries of foreign banks. Only a few were established by the Chinese and, even so, their size was relatively small (Jao, 1991). This was mainly due to the power of the Hong Kong Government. They were in favour of the British.
The richness of the British influence in HSBC can be seen from the nationalities of its employees. The first Chinese executive was not employed until after the Second World
War. In the early days, the bank hired some Chinese compradors as interpreters for dealings between the Chinese and Europeans. Most of the staff, including clerks and senior officers, were expatriates from Britain and Portugal or were Eurasian. Even by the late 1980s, one commentator noted that “[t]he top executives are all expatriates, and the highest ranking Chinese has not yet reached general manager level and board” (Rafferty,
1989, 287).
4.6.2 HSBC as the de facto central bank of Hong Kong
The importance of the role of HSBC in Hong Kong is evident in its close relationship with the Hong Kong Government. A central bank is “a banker for the government of the country and a banker for the country’s banks, and, when a bank needs currency or needs to make payments to the government or other banks, it can use its deposits with the central bank” (Scott, 1986, 35). Hong Kong flourished as a centre for international trade mainly because of Hong Kong’s use of the British-based legal system. Its transparent, predictable and enforceable legal environment and regulatory regime helped to maintain successful economic development. It became the location of choice for head offices or regional headquarters for British and other major trading firms engaged in the China trade, even though Shanghai surpassed Hong Kong as a metropolis in much of the 19th
Chapter 4 Historical Context 127 and the first half of the 20th century. Well-connected firms based in the colony, like
Jardine Matheson and the Hongkong and Shanghai Bank, soon built up a social and financial network to leading international cities in Europe, America and elsewhere in
Asia. The links to London were particularly important, as it was the global pivot of trade and capital (Tsang, 2004).
HSBC and the Exchange Fund39 have been referred to as a de facto Central Bank until the establishment of HKMA in 1993. The bank could also manipulate short-term money market conditions by increasing the net balance which would lead to an increase in the net supply of liquidity, and a fall in the interbank rate, and vice versa. Any changes in the interbank rate would affect the decision of the HKAB to change the deposit rates, and the leading banks would then change their best lending rate (Ho et al., 1995). Under this old system, HSBC was the ultimate clearing bank. There was no requirement for the bank to hold an account with any other entity. The net clearing balance of other banks with the bank was affected by the transactions of the bank with other banks. A link between
HSBC and the Exchange Fund, with the “accounting arrangements”, was established to control interbank liquidity in 1988. The government enabled the Exchange Fund to engage in open market operations to influence interest rates and money supply as a typical Central Bank does. With the “accounting arrangements”, HSBC was required to maintain a Hong Kong dollar account with the Exchange Fund and tried to keep the account’s balance equal to the net clearing balance in the local banking system. It acted
39 The Hong Kong Exchange Fund, which was established by the Currency Ordinance in 1935, held the backing for the note issue of Hong Kong. It also held the foreign currency assets and fiscal reserves. Hong Kong Monetary Authority 2007. The Exchange Fund. [cited 20 December 2007 ], available from http://www.info.gov.hk/hkma/eng/exchange/index.htm.
Chapter 4 Historical Context 128 as a clearer for all banks in Hong Kong. It charged interest on any shortfall below the equilibrium point. If the interbank market produced a net clearing balance exceeding the balance, it would have to pay interest to the Exchange Fund at a punitive rate (Freris,
1991b, Jao, 1991, Rafferty, 1989). Aoki et al. (1997) commented that if Hong Kong is in any financial repression, HSBC will be the leader of the Foreign Exchange Banks
Association to overcome the problem. This is because HSBC served as a central bank of
Hong Kong.
Hong Kong’s currency notes are issued by commercial banks, and not by the currency board. But note-issuing banks are legally required to hold non-interest bearing
Certificates of Indebtedness (CI) issued by the Exchange Fund to provide backing for banknote issuance. Before December 1996, banks maintained their clearing accounts with HSBC. The clearing balances of the banking system were not on the currency board’s balance Sheet. Wei and Li (1995) commented that the bank enjoyed a virtual monopoly over the financing of trade with China and became the leading bank in Hong
Kong.
4.6.3 Political influence of HSBC
‘Power in Hong Kong resides in the Royal Hong Kong Jockey Club;
Jardine, Matheson and Co.; the Hongkong and Shanghai Bank
Corporation; and the Governor – in that order.’
(Crisswell, 1981, 71, Hughes, 1976, 52, Rafferty, 1989)
Chapter 4 Historical Context 129
This is the old saying that four people run Hong Kong. A lot of researchers commented that HSBC had power over the government in Hong Kong (Hughes, 1976; Rafferty,
1989). The political influence of the Bank can be seen in a number of incidents throughout the history of Hong Kong. By the 1880s, the Bank was acting as banker to the Hong Kong Government and as sole or joint banker for British government accounts in China, Japan and Singapore (HSBC Holdings plc, 2004). On of the bank’s main contributions to business services is the issuing of banknotes. Because of the underlying power of HSBC and its close relationship with the British government, the bank did not have to respond passively to institutional pressures.
The Chief Manager of the Bank could influence the economic policy in Hong Kong. The bank dominated in the development of industry in Hong Kong. After the signing of the
Ottawa Agreement on Imperial Preference, which allowed free trade in the British and the Commonwealth markets in 1932, manufacturing industry started to grow rapidly with increases in exports. The economic policy of Hong Kong promoted this trade at the expense of local industry, based on a policy review conducted in response to the Great
Depression. This policy of no tariff or market protection measures in pursuance of free trade was also implemented in other British colonies. Any tariff or market protection measure which assisted industrial growth was rejected in pursuance of free trade. A
Committee was formed in 1934 to study the causes and effects of the Depression and make recommendations for improvement. In response to institutional pressures, HSBC choose to co-opt the source of the pressure (Oliver, 1991). The then HSBC chief manager, Vandeleur Grayburn, was one of the representatives on the Committee. In this case, HSBC could strategically influence the institutionalized beliefs about acceptable
Chapter 4 Historical Context 130 practices by having a member on the Committee. As a result, the only solid recommendations to assist industry were to set up a Special Committee to review the economic welfare of the colony, and that the government should avoid the introduction of stringent enforcement of legislation on working conditions. The recommendations were adopted without any alternative view. The local Hong Kong merchants were indifferent about the final decision as they were involved mainly in entrepôt trade between China and Western Europe, which was not affected by the industrial sector
(Ngo, 1999).
During the 1950s, there was considerable political pressure from representatives of small business who felt discriminated against by banks because they lacked the collateral or reputation to establish their creditworthiness. In addition, there was a cultural dimension in Hong Kong where the largest bank was controlled by British expatriates while industry was mainly conducted by Chinese. There was also a further division in the manufacturing sector between Shanghai large-scale industry and Cantonese smaller-scale industry. This is an example of the cultural gulf between finance and industry cited in
Britain (Schenk, 2004b).
In 1967, the industrialists and the Hong Kong government wanted to set up an industrial bank. However, the then HSBC deputy chief, Clague, advised that if HSBC would not take such risks, the Hong Kong government should not do so either. The power of the banking industry in society can been seen from the composition of the 1959 Industrial
Bank Committee, whose Chairman was the deputy Finance Secretary of the Hong Kong
Government. There were also five unofficial members of the Executive and Legislative
Chapter 4 Historical Context 131
Councils40, none of whom had any industrial background, though three came from the banking sector (Choi, 1999, Ngo, 1999). The dominant committee members from the banking sector resented the notion of setting up a public or semi-public financial institution. Being one of the members of the Executive council, HSBC was protecting itself in the banking sector.
Furthermore, the chief mangers/chairmen of HSBC had been granted seats in the
Legislative Council (Legco) since 1872. They were members of and participated in the
Executive Council (Execo) of Hong Kong from 1921. HSBC representatives counted for about half of the non-official members in the Executive Council. The Executive council was an instrument for assisting the colonial governor in policy making. The governor consulted the members in the Execo on all major policy matters. J. H. Bremridge, director of HSBC, was appointed by the governor as the Financial Secretary during
1862-86. This demonstrated HSBC’s penetration of business interests and influence into state/government of Hong Kong. The interests of HSBC could be fully realized in the government policy making process. For example, being non-official members in the
Executive and Legislative Council, they were continuously consulted by Government in matters of their expertise (King, 1991). On the other hand, bankers from the Standard
Chartered Bank seldom participated directly in the government body except in 1982 -
1984. This may due to the fact that HSBC directly handled the Hong Kong
Government’s banking business in Hong Kong.
40 The name of this organization was changed to Office of the Members of the Executive and Legislative Council in 1986 because the term “unofficial” was misleading (Roberti, 1994).
Chapter 4 Historical Context 132
As seen in Figure 4-10, local Chinese bank representatives, such as Bank of East Asia
(1960 – present), Shanghai Commercial Bank (1971-1978), Wing Lung Bank (1982-
1984), Liu Chong Hing Bank (1986-1988), Hang Lun Bank (1986-1990), were invited to participate in Execo and Legco. However, they were a minority in those councils and their numbers were much less than those of the British bankers, particularly in the controversies related to the British banks’ interest. The formulation of banking policy was dominated by the British network. HSBC played an increasingly dominant role in the policy-making process from the 1960s to 1980s (refer to Figure 4-11, Figure 4-12, and Figure 4-14). They had three to five votes in Legco and Execo, out of around 13 to
15, as they were appointed as members by the government. Therefore, HSBC had full strength in influencing the formal policy-making process. British conglomerates also got their seats in Legco and Execo and usually concurred with the British bankers.
Chapter 4 Historical Context 133
Figure 4-10 Number of representatives in the Executive/Legislative Council of Hong Kong (1967-2005)
Other41 Chase Exco/ Hang Seng Standard Bank of Year HSBC Chinese Jardine Swire Manhattan Legco Bank Chartered East Asia bank Bank Exco 2 0 0 2 0 1 0 1967 Legco 0 0 0 1 0 0 1 Exco 2 0 0 2 0 0 0 1969 Legco 2 1 0 2 0 1 3 Exco 2 0 0 2 0 0 0 1971 Legco 1 1 0 1 1 0 2 Exco 2 0 0 1 0 0 1 1974 Legco 2 1 0 1 1 0 1 Exco 1 0 0 1 1 0 1 1976 Legco 2 1 0 1 0 0 0 Exco 1 0 0 1 1 0 0 1978 Legco 2 1 0 1 0 0 1 Exco 2 0 0 1 0 0 0 1980 Legco 2 0 0 1 0 1 1 Exco 3 0 1 1 0 1 1 1982 Legco 2 0 0 0 1 1 2 Exco 4 1 0 1 0 1 0 1984 Legco 3 0 1 0 1 0 2 Exco 3 1 0 0 0 0 0 1986 Legco 4 0 0 1 2 0 2 Exco 2 1 0 0 0 0 1 1988 Legco 3 0 0 1 2 0 1 Exco 3 0 0 1 1 0 1 1990 Legco 0 0 0 1 1 1 0 Exco 2 0 0 1 0 0 1 1992 Legco 2 0 0 0 0 1 0 Exco 2 0 0 1 0 0 1 1994 Legco 2 0 0 1 0 1 0 Exco 2 0 0 0 0 0 1 1995 Legco 1 0 0 1 0 1 0 Exco 1 0 0 0 0 0 0 1996 Legco 0 0 0 1 0 1 0 1997- 2002 0 0 0 0 0 0 0 1 2002- 2005 0 0 0 1 0 0 0 0
41 Shanghai Commercial Bank, Wing Lung Bank, Liu Chong Hing Bank, and Hang Lun Bank.
Chapter 4 Historical Context 134
Figure 4-11 Distribution of Execo members
Execo 100% HSBC 90% 80% Hang Seng Bank 70% Standard Chartered 60% 50% Bank of East Asia 40% Other Chinese bank 30% 20% Jardine 10% 0% Swire Chase Manhattan Bank 9 0 4 6 2 5 6 8 8 88 9 9 9 9 9 1967 1 1971 1974 1976 1978 19 1982 1 1986 1 1990 1992 1994 1995 1 -200 200 7 2- 0 0 Year of election 199 2
Figure 4-12 Distribution of Legco members
Legco 100% HSBC 80% Hang Seng Bank 60% Standard Chartered 40% Bank of East Asia 20% Other Chinese bank 0% Jardine Sw ire 8 6 4 71 7 80 8 88 9 95 Chase Manhattan Bank 9 9 9 05 196719691 1974197619 19 1982198419 1 1990199219 1 1996-2002-20 997 002 Year of election 1 2
After the banking crises in the 1980s, HSBC and other British banks worried about the impact of the crises on Hong Kong’s reputation as a financial centre. Consequently they proposed in the Execo and Legco consideration of at least three essential policy outcomes: first, minimizing the mismanagement, fraud and imprudential lending practices of all banks in Hong Kong; secondly, assuring that all banks maintain a reasonable level of liquidity; and thirdly, upholding the interest monopolization of the
British banks in Hong Kong. The ordinances enacted in 1986 basically fulfilled the desires of the British banks.
Chapter 4 Historical Context 135
Moreover, Dame Lydia Dunn, “the Iron Lady of the East”, as the British press called her, was the first female on the board of HSBC (Roberti, 1994, 249). She served as a non- executive director of HSBC from 1981. She was also was the Senior Unofficial Member of the Legislative Council and Executive Council in Hong Kong from 1985-1992. She is still a board member of HSBC (HSBC, 2006). The Executive Council was first set up by the colonial government. Ex-officio members were the Chief Secretary, Chief
Financial Secretary, Financial Secretary and Attorney General. Non-official members were appointed from among prominent people in the colony. Non-official members made up the majority of the council.
The statue of Sir Thomas Jackson is still standing in Queen Victoria Park outside
HSBC’s main building in Central Hong Kong. He was the Chief Manager of HSBC between 1876 and 1902. He was working for both the Hong Kong and British governments. His statue is in recognition of his excellent services to the bank at the period. This is the only statue left in Hong Kong that does not depict a member of the
British royal family. Sir Thomas Jackson’s contributions to Hong Kong’s banking system include leading the bank to be the foremost financial institution in Asia, and to lead the bank’s growth. His statue was set up with the statue of Queen Victoria and other members of the royal family. It was a historical site that represented the development of the central district of Hong Kong by the British Government. This formal colonial square had beautified and decorated Victoria City and shown the power of the British
Empire. It had been the landmark that symbolized colonization (Hung, 2002).
Chapter 4 Historical Context 136
Figure 4-13 Sir Thomas Jackson statue
The political influence of the bank can also be seen from the stock market crash in 1987.
On 19th October 1987, the Hang Seng Index dropped 420 points, closing at 3362. The
Hong Kong stock market lost more than HK$65 billion in value. Trading on the Hong
Kong Futures exchange was suspended twice, as the fall exceeded the maximum permitted amount. The futures market was in danger of collapse. However, the government considered that the market should be ‘left to find its own level’ (Winn, 1987,
1). The Chairman of the futures exchange, with a group of lending brokers, approached the Financial Secretary of the Hong Kong Government to bail out the futures market.
They were rejected. The financial secretary held a secret meeting with the chairman of
HSBC, Mr. William Purves. After the discussion, he reversed his decision and assisted in rescuing the futures market and employed Hambros Bank to advise on the policy for the futures market (Barnes and Marron, 1987, Mulcahy, 1987, Wall Street Journal,
1987). This indicated that HSBC had a great impact on governmental policies in the financial sector.
Chapter 4 Historical Context 137
Figure 4-14 Name of representatives of HSBC in Executive/Legislative Council (1967- 1996) Membership in Membership in Year Directors/Bankers in HSBC Executive Council Legislative Council Saunders, J.A. (Chairman) √ 1967 Clague, J.D. √ Saunders, J.A. (Chairman) √ Clague, J.D. √ 1969 Herries, M.A. √ Browne, H.J. √ Saunders, J.A. (Chairman) √ 1971 Clague, J.D. √ Browne, H.J. √ Sayer, G.M. (Chairman) √ 1974 Clague, J.D. √ Williams, P.G. √ Sayer, G.M. (Chairman) √ 1976 Williams, P.G. √ Bremridge, J.H. √ Williams, P.G. √ 1978 Bremridge, J.H. √ √ Sandberg, M. (Chairman) √ 1980 Bremridege, J.H. √ √ Newbigging, D.K. √ Sandberg, M. (Chairman) √ Bremridge, J.H. √ Financial Secretary 1982 Swaine, J.J. √ Newbigging, D.K. √ √ Sandberg, M. (Chairman) √ Bremridege, J.H. √ Financial Secretary 1984 Swaine, J.J. √ Newbigging, D.K. √ Dunn, L. √ √ Sandbery, M. (Chairman) √ Bremridge, J.H. √ Financial Secretary 1986 Swaine, J.J. √ Dunn, L. √ √ Sohmen, H. √ Purves, W. (Chairman) √ Swaine, J.J. √ 1988 Sohmen, H. √ Dunn, L. √ √ Purves, W. (Chairman) √ 1990 Swaine, J.J. √ Dunn, L. √ Gray, J.M. (Chairman) √ Swaine, J.J. √ 1994 Dunn, L. √ Cheung, Hoi-chuen (Manager) √ Gray, J.M. (Chairman) √ 1995 Dunn, L. √ Cheung, Hoi-chuen (Manager) √ 1996 Cheung, Hoi-chuen (Manager) √
Chapter 4 Historical Context 136
Figure 4-13 Sir Thomas Jackson statue
The political influence of the bank can also be seen from the stock market crash in 1987.
On 19th October 1987, the Hang Seng Index dropped 420 points, closing at 3362. The
Hong Kong stock market lost more than HK$65 billion in value. Trading on the Hong
Kong Futures exchange was suspended twice, as the fall exceeded the maximum permitted amount. The futures market was in danger of collapse. However, the government considered that the market should be ‘left to find its own level’ (Winn, 1987,
1). The Chairman of the futures exchange, with a group of lending brokers, approached the Financial Secretary of the Hong Kong Government to bail out the futures market.
They were rejected. The financial secretary held a secret meeting with the chairman of
HSBC, Mr. William Purves. After the discussion, he reversed his decision and assisted in rescuing the futures market and employed Hambros Bank to advise on the policy for the futures market (Barnes and Marron, 1987, Mulcahy, 1987, Wall Street Journal,
1987). This indicated that HSBC had a great impact on governmental policies in the financial sector.
Chapter 4 Historical Context 139 was finally signed in Beijing on 19th December by Prime Minister Thatcher and Premier
Zhao Ziyang. The transitional period began and the agreement came into effect after ratification in 1985.
Although both parties proclaimed that the agreement was satisfactory, the negotiation was marked by distrust. Sino-British relations were questioned when the last Governor of Hong Kong, Chris Patten, appointed in 1992, failed to agree with the Chinese on the method for the September 1995 election of the Legislative Council (Yahuda, 1995).
Patten proposed an electoral reform by lowering the voting age from 21 to 18 and defining the existing functional constituencies and nine new ones so broadly as to give almost anyone with a job a vote. He warned that without “a credible legislature, fairly and openly elected,” the rule of law would be undermined and this in turn would put at risk “the maintenance of Hong Kong’s prosperity and freedom” (Roberti, 1994, 305).
After the rejection of Patten’s proposals, the Preliminary Working Committee was set up for the Preparatory Committee to be established according to the Basic Law in 1996.
The Preparatory Committee was set up in 1996 and was responsible for preparing for the establishment of the HKSAR, including the prescription of the method for the formation of the first government and the first Legislative Council of the HKSAR
(Hong Kong Special Administrative Region, 1997, Kuan, 1996, Pepper, 1996). The
Hong Kong members of the Basic Law Drafting Committee were selected by Xu
Chapter 4 Historical Context 140
Jiatun42 and appointed by the Standing Committee of the National People’s Congress
(Roberti, 1994, Yahuda, 1995). Beijing had the power to amend the Basic Law, except those clauses about the principles laid down in the Joint Declaration (Roberti, 1994).
The Chinese authorities appointed 44 people as the first group of advisors on Hong
Kong affairs in 1992. More than seven hundred had been chosen by early 1995. They were chosen from business, the professions, the universities, former civil servants, former drafters and consultants on the Basic Law, trade unions and representatives of
Chinese institutions. However, none of them came from the Democratic Party led by
Martin Lee, who were classified as pro-British democrats, or any other aligned groups
(Murphy, 1995, 1996). Nor did the preparatory committee include representatives from business firms clearly linked to the Hong Kong colonial business and administrative elite, such as HSBC. Beijing was criticized by the general public in Hong Kong because the Preparatory Committee did not represent the general Hong Kong community. This might affect all the British-based companies that once had dominance in Hong Kong. The greatest impact might have been on HSBC because it was the largest bank in the colony and once served as the central bank of Hong Kong before the
HKMA43 was set up. In response to the anxiety about the bank’s future shown by the general public, the bank extended the period for repaying housing loans/mortgages to 20 years, which was well beyond 1997 (Bonavia, 1983, Overholt, Asian Survey, Roberti,
1994).
42 Xu Jiatun was the director of the Xinhua News Agency in Hong Kong. This News Agency is the official press representative of the Chinese Government and reports directly to the Public Information Department of the Communist Party of China. 43 It will be further discussed in section 4.6.2.
Chapter 4 Historical Context 141
The distrust was aggravated by the Tiananmen incident of 4th June 198944: A series of student-led pro-democracy demonstrations in China (Hong Kong Standard, 1989,
Schell, 2001, Wai, 1989). This alerted Chinese leaders to the danger of political subversion from Hong Kong. The protests ended in violence when the 27th Army of the People's Republican Army used force to restore order in the capital city. The violent suppression of the Tiananmen Square protest caused widespread international condemnation of the Chinese government. The incident eroded confidence in China and fuelled fresh doubts about Beijing’s ability to accept the freedoms so essential to what made Hong Kong work (Allen, 1997, Manning, 1997, Tsang, 2004, Yahuda,
1995). The British government also had to restore the confidence of people in Hong
Kong in their future sovereignty. Both the British government and the Chinese government wanted to achieve a smooth transition and a stabilized economy in Hong
Kong.
Although Hong Kong is a westernised metropolitan city, Chinese traditional culture is embedded in the society. For example, a small incident happened during the time of negotiation. Margaret Thatcher slipped and fell on her hands and knees on her way out of the Great Hall after the discussion. The superstitious in Hong Kong saw it as a bad omen because it looked like she was making “a crude kowtow in the direction of Mao’s mausoleum” (Roberti, 1994, 49). It was seen as a bad sign of the fall of Hong Kong.
44 Thousands of students from different provinces of China who gathered in Tiananmen Square to fight for democracy a number of them ended up being massacred, with hundreds of bystanders killed. The news was broadcast by media to the world, except for China itself.
Chapter 4 Historical Context 142
Traditional Chinese were very superstitious and they saw it as a bad sign for Hong
Kong.
Feng shui interpretation of historical context in HSBC
This chapter presents a very Western representation of the history. But I would also like to give a Chinese interpretation of this. And it is interesting that out of both traditions, the same theme emerges. Feng shui45 is very important to the daily life of the
Chinese. They believe that feng shui affects the future. Even HSBC built their first headquarters in Hong Kong with the influence of feng shui, in the construction of the building. It is located in a so-called “dragon’s vein” that emanates from the Victoria
Peak. There was a rumour that HSBC is guaranteed that no structure built under an agreement with the government will block its view of the harbour. This is considered to have good feng shui. Moreover, two bronze lions, symbolizing strength and good fortune, have been placed at the entrance of the headquarters in Hong Kong. The bronze lions are believed to contribute to the steady revenue of the bank.
The two metal rods on top of the HSBC building are pointed at the Bank of China
(BOC), its rival bank. The BOC building was designed and constructed near the HSBC building at the end of 1980s. Its sharp edge with triangular glass surfaces was considered to cut off a feng shui stream flowing into the HSBC building (refer to Figure
4-15). The BOC building has a modern architectural design but is still sensitive to the
45 Feng Shui (literally translates to “wind-water”) is an ancient Chinese practice of arrangement and placement of space to achieve and promote prosperity, harmony, balance and comfort with the environment. It had been practised for more than three thousand years.
Chapter 4 Historical Context 143 perspective of Chinese culture. Therefore, the two metal rods were regarded as a classic feng shui technique to protect the building from the negative energy of the dreaded triangles by deflecting the energy back its source (Haruhiko, 2003).
Figure 4-15 Buildings of HSBC and BOC in Hong Kong
The influence of Chinese culture can be seen in the historical development of HSBC.
For example, HSBC consulted a feng shui master in locating its buildings. This proved that the tradition of Chinese culture still deeply influences the corporate culture of the bank. For example, when opening new branches in Canada, firecrackers were exploded to ward off evil spirits, along with the dotted eyes of the lion (Davis, 1995, New York
Times, 1997). There was an element of mimetic isomorphism as HSBC sought to maintain its legitimacy with the Chinese culture. It was believed that feng shui could benefit a company because it helped local staff to feel more secure, especially when working with a foreign company. They wanted to keep their local staff in good spirits
Chapter 4 Historical Context 144 and saw it as a service to them. The bank even provided a feng shui consultation allowance for its senior directors’ homes in Hong Kong (BBC News, 2000).
There is a rumour that the Hong Kong government was influenced by the Chinese government, and tried to destroy HSBC’s feng shui . They tried to demolish the British colonial buildings as much as possible. The famous Star Ferry pier, which connected
Hong Kong Island to Kowloon, was demolished on 13th November 2006. The pier was situated in front, forming a straight line with the HSBC. Once it was taken away, it was said to affect the feng shui of the bank because it was no longer situated on the main route of the best feng shui. By coincidence, the share price of HSBC dropped by more than 1.5% the following day (Apple Daily, 2006) .
The negotiations between the two governments had the common aim of maintaining the stability and prosperity of Hong Kong after China resumed sovereignty over Hong
Kong, after 155 years of British colonial rule. From the mid-1980s, increasing integration with China was evident when increasing industrial activities were relocated across the border in Guangdong province to benefit from the plentiful supply of land and labour in the hinterland. In 1992 some three million mainland labourers worked directly for Hong Kong entrepreneurs (Chau, 1993). Enterprises in China also started to invest heavily in all sectors of Hong Kong’s economy in order to acquire expertise and gain greater access to global trade. Since 1993, some major companies in China sought listing on the Hong Kong Stock Exchange (Auyeung, 1997). There were more than two thousand mainland companies listed in Hong Kong at the end of 2007. This is because
Chapter 4 Historical Context 145
Hong Kong could leverage its world standard supervision to help China’s enterprises to promote their market-oriented reforms.
In the late 1970s, Hong Kong’s business sector was an arena for British companies like
Jardine Matheson, Wheelock Marden, Hutchison Whampoa, and the Swire Group.
Since then, enterprising Chinese groups with investments in shipping, property, and the textile industry have risen to manipulate some of the British-founded concerns. They tended to trust the Chinese-based bank.
In late 1983, HSBC designed a new corporate identity. The logo consists of a hexagram composed of red and white triangles derived from the company’s old flag (King, 1991,
555). The local designer of the new logo, Henry Steiner, commented that HSBC needed to update its identity for an international audience because the old one was very colonial. The HSBC website offers a similar explanation for the development of the hexagon symbol. It explains that a number of Hong Kong companies established in the
19th century were set up by the Scottish and the design of their companies’ flags was based on the Scottish flag.
This shift from a colonial design to a more abstract symbol implied that the company had shifted from being the financier of the Britain-China trade to a multinational financial leader. The shortened name, HSBC, is also a sign that they have moved away from their Asian colonial roots to become an international corporation It followed the international trend in the 1960s to change complex heraldic symbols to simple abstract logos (Huppatz, 2005). The change of logo symbolized that the bank was willing to
Chapter 4 Historical Context 146 corporate with the Chinese Government. HSBC’s identity carried the strapline of “The world’s local bank” from 2002. It emphasized the bank’s experience and understanding of a great variety of markets and cultures.
Figure 4-16 Logo of HSBC 1983-present
Chinese leaders believe that switching from a pro-Britain to a pro-China elite will have little or no impact on Hong Kong’s economic success, and mainland and pro-China companies in Hong Kong will enjoy far greater advantages after 1997 than British companies ever did (Roberti, 1994). The influence of HSBC was declining even before the transition. HSBC has long been a resource of finance for China. However, the
Bank of China was chosen by the government in 1986 as its partner in bidding for financing the construction of the new road and rail tunnel under Hong Kong harbour
(Rafferty, 1989). The special report of CFO Asia (2002) suggested the HSBC’s presence in China is limited because of ‘its ties to the colonial past’ which may handicap it in establishing a stakehold in China (Calabro and Nyberg, 2002). With the disturbance of the establishment of BOCHK, HSBC had to change its British image to a more neutral position, which was reflected in the new bank logo.
Chapter 4 Historical Context 147
The cultural and social systems in China and Britain are very different. Under the colonial system, the British tried to maintain a wall between government and business.
But after 1997, the wall between government and business might be torn down, or at least have large holes punched in it. Tung Chee Hwa was elected as the first Chief
Executive of Hong Kong. He was elected by a 400-member Election Committee, consisting of members from various sectors and appointed by the Chinese government.
In the second term, the Election Committee was enlarged to 800 members and Mr. Tung was the only candidate in the election. He came from a leading family in Hong Kong which was involved in shipping. The family had a close relationship with China when
Mr. Tung turned to Henry Y.T. Fok for an emergency loan for the Communist-owned
China Ocean Shipping Company (Rafferty, 1989). The strong relationship between the
Chinese government and business is clear to see when a businessman became the Chief
Executive of China.
Technically, the Chief Executive will be accountable to the Central Government as well as to the region. According to the Basic Law, Hong Kong will exercise an independent executive, administrative and judicial authority except for the conduct of external defence and foreign affairs. It is not subordinate to any departments of the Chinese
Central Government or provinces, autonomous regions and municipalities. However, in practice, Hong Kong is greatly dependent on the mainland and the Chief Executive had arranged working relations with both central and regional authorities. After Tung served as the Chief Executive of Hong Kong, he announced that all eligible senior civil servants would remain in place after reversion. This put Tung in a difficult situation
Chapter 4 Historical Context 148 because the old civil servants from the British colony had a different political point of view (Manning, 1997).
4.7.1 De facto central bank status change
HSBC was disadvantaged by the change of sovereignty. The clearing and settlement task was taken over in phases by the HKMA after the reform. Before the reform in
1995-1997, HSBC acted as the clearing bank for the entire banking system in Hong
Kong. It held other banks’ funds for periods of time, but had no need to pay interest on them. HSBC served as clearing bank to the banking system, and wielded considerable influence over monetary conditions. That capability was dismantled progressively by the HKMA’s subsequent assumption in 1996, via the Exchange Fund, of the role of settlement institution for the local payments system (Hong Kong Monetary Authority,
2002). However, the government felt that the existing system was antiquated and that it created unnecessary volatility in the inter-bank funds market. For example, private commercial transactions of HSBC could influence the overall level of liquidity in the banking system (Federal Reserve Bank of San Francisco, 1999). After the new accounting arrangement, HKMA had taken over the privileges of commercial benefit and confidential information. HSBC no longer enjoyed the ‘virtual monopoly’ of financing in Hong Kong (Wei and Li, 1995). The Exchange Fund does not have to pay interest to the bank for credit balances but the bank has to pay interest to the Exchange
Fund if the balance is less than the net clearing balance or if the net clearing has a debit balance.
Chapter 4 Historical Context 149
4.7.2 Rise of the Bank of China (BOC)
The Bank of China Group had become Hong Kong’s second largest bank in the mid-
1980s. It financed heavily those companies in Hong Kong which were connected to the
People’s Republic of China (PRC). China replaced the UK as the third-largest foreign investor in Hong Kong after the USA and Japan. In 1985, the PRC became the largest trading partner of Hong Kong (Hong Kong Standard Post, 1988). The BOC Group became the leading financier of economic relations between Hong Kong and China.
The economic influence of Chinese capital became increasingly significant in this transactional period.
BOC and HSBC supported the declining HK dollar being pegged to the US dollar when the HK dollar crisis broke out in 1983 because of the political confidence problem. It also joined with HSBC to stabilize the Ka Wah Bank, a local Chinese bank in Hong
Kong, in 1987 during the stock market crash. BOC provided HK$100 million stand-by credit for the Hong Kong commodity Futures Exchange to prevent further collapse
(Ghose, 1995). In 1998, a wholly owned subsidiary of BOC, Bank of China
International Holding Ltd (BOCI) was set up in Hong Kong as a regional investment bank. For many years it provided corporate finance, securities broking, project finance and direct investment services in Hong Kong and the UK with a registered capital of
US$ 1 billion. BOCI operated in Hong Kong and London, with its headquarters in
Hong Kong. It is the largest broker in Hong Kong (Gilley, 2000). It also has 10 seats at the Stock Exchange of HK Ltd., and the largest retail broking network in Hong Kong.
Chapter 4 Historical Context 150
Moreover, BOC began to issue banks notes in May 1994. And from 1996 onwards it also became the chairman of the HKAB alternatively with the HSBC and the Standard
Chartered Bank. Before then the chairmanship only alternated between the two British banks.
4.7.3 Note-issuing
During the 1990s, all legal currency was issued by HSBC and Standard Chartered Bank, with 90% of them issued from HSBC. All of them issued HK dollars, and had 100% foreign currency reserve for backup (Hong Kong Monetary Authority, 2004a).
Supervision was provided by the Foreign Exchange Fund and it was under the control of the Treasury of Hong Kong. However, the Bank of China (BOC) began issuing bank notes in Hong Kong in 1994. This is the first time a national bank of China participated in issuing bank notes in Hong Kong.
After the establishment of the HKSAR in 1997, coins with Queen Elizabeth II’s portrait were gradually withdrawn from circulation. The flower, Bauhinia blakeana, was used to replace the Queen’s portrait. It symbolized the withdrawal of the British and the beginning of a new era. The new design was highly sensitive: for political and economic reasons, the design process of the new coins could not be entrusted by the
Chinese Government to an artist but was undertaken by Joseph Yam, Chief Executive of the HKMA, who found in the bauhinia the requested ‘politically neutral design’.
Chapter 4 Historical Context 151
4.7.4 Political aspects
The power of HSBC was further affected when political leadership in the local banking sector shifted to the Bank of China. A sign of the times was when the Bank of China took over the chairmanship of the Hong Kong Association of Banks for the first time in
1996. HSBC lost its traditional seat on the Executive Council, the inner sanctum of non-officials who advise the chief executive of Hong Kong. Until 1995, the chairman of the bank, always a Briton, occupied the seat. In that year it was taken up by the bank’s most senior Hong Kong Chinese officer, Vincent Cheung. But he was among the half-dozen advisors not reappointed when the chief executive of Hong Kong announced his new council in January 1997. This change is clearly a result of political sentiment. He was succeeded in the position by Antony Leung, regional general manager of the Chase Manhattan Bank, who had close ties to Beijing. He was one of the members of the China-appointed Preparatory Committee responsible for setting up the first post-1997 government (Allen, 1997).
HSBC responded by expanding its group to Britain and it transferred its global headquarters from Hong Kong to London. It acquired a 15% stake in the Midland Bank, which is a large British bank, and the rest was bought in 1992. It moved its office in
1993 (Allen, 1997). When HSBC moved its domicile to London in 1990, it had to consult China’s prime minister in advance. In order to maintain its legitimacy in Hong
Kong, HSBC conformed with the tradition of Chinese culture. Again in 1992 when
HSBC took over Midland Bank, the bank also consulted with Beijing in China to satisfy
Chapter 4 Historical Context 152 that the process of consultation met the minimum conditions (Segal, 1993). This clearly reflected that the British no longer dominated in Hong Kong.
Before 1997, a large portion of the seats in the Executive and Legislative Councils were granted to the representatives of British banks and British conglomerates. However,
HSBC’s representatives, including Vincent Cheng, once members of Governor Chris
Patten’s inner circle, lost their positions in the Executive council after 1997 (Yueng,
1997) (refer to Figure 4-11 and Figure 4-12). He has been replaced by Leung Kam- chung, regional general manager of the Chase Manhattan Bank. Leung became an unofficial member of the Executive Council during 1997- 2001 and later (1st May 2001) was selected by Tung as the Chief Financial Secretary of the Hong Kong Government.
Moreover, before the introduction of the deposit insurance scheme, which was discussed in section 4.6.1, HSBC actively campaigned against any such proposal
(Chartered Institute of Bankers, 1992, Chu, 2000, Hsu, 1997). As a member and
Chairman of HKAB, HSBC could influence the decisions of the association and represent all the banks in Hong Kong. The bank/association argued that they would ensure that banks in Hong Kong would be less likely to declare bankruptcy. It also argued that the bank management might not be prudent and it was unfair for the well- established banks such as HSBC to share the costs of the deposit insurance scheme.
Therefore, the Banking Ordinance 1986 was not consumer protection legislation. With the absence of deposit insurance, the government had no legal obligation to ensure that the depositors of a bankrupted financial institution would get back their full deposit. It depended on the government’s de facto insurance system to compensate the depositors
Chapter 4 Historical Context 153 up to a certain amount if the banks failed (Hsu, 1997). However, the deposit insurance ordinance was later enacted in 2004. It started operating in late 2006. According to the scheme, all licensed banks in HK are members of the scheme unless otherwise exempted by the Hong Kong Deposit Protection Board.
4. 8 One country, two systems
4.8.1 Two monetary systems
There are distinctive differences between the monetary systems of Hong Kong and
China. Hong Kong’s monetary system operates more in line with international practices compared with China’s. The two monetary systems are independent of each other and neither system is inferior or superior to the other. Assets and liabilities of the two individual monetary systems are considered as separate foreign assets and liabilities.
Hong Kong’s banks operating in the monetary system of China are treated as foreign banks and vice versa. Hong Kong will not seek and will not be given special privileges by the Chinese Government (Yam, 1996).
4.8.2 Two monetary authorities – HKMA vs PBC
The monetary authorities of Hong Kong and China are independent because the monetary systems are different. HKMA supervises the banking system in Hong Kong
(discussed in section 4.7.1) and the People’s Bank of China (PBC) is the central bank in
China. According to the Deputy Governor of the People’s Bank of China, Chen Yuen,
HKMA will only be accountable to the Hong Kong Government and PBC will continue its supervision of banks in China (Yuan, 1996). Chinese banks are subject to the same
Chapter 4 Historical Context 154 licensing criteria and supervision by the HKMA as any other foreign banks in Hong
Kong. Banks incorporated in Hong Kong are subject to the same licensing criteria for foreign banks and under the supervision of the PBC if they operate in China (Yam,
1996).
4.8.3 Two currencies – HK$ vs RMB
The Hong Kong dollar would continue to be the legal tender of Hong Kong after 1997 according to the Basic Law. The Hong Kong dollar would circulate in Hong Kong and the Chinese Renminbi (RMB) would still be the legal tender circulating in China. As with the treatment of monetary authorities, the Hong Kong dollar would be treated as foreign currency in China and vice versa (Yam, 1996). There were pressures to abolish the Hong Kong dollar. However, due to the constitutional protection for the continuity of the Hong Kong dollar under the Basic Law and the convertibility of RMB, there was little market demand for RMB in Hong Kong.
4.8.4 Two professional accounting bodies
In contrast to Hong Kong, the first professional accounting body - the Accounting
Society of China (ASC) - was not established until the 1950s, and it was the Chinese government which issued accounting rules to regulate the profession. However, the
Certified Practising Accountants system was suspended in 1949 as there was no need for it in communist China. It was reorganized in 1980 when China opened its doors to foreign investment in 1979 (Wang et al., 2005). The rapid growth of its economy, international trade, and securities markets has shaped new objectives for financial
Chapter 4 Historical Context 155 reporting in China. State-owned enterprises began to resemble profit-oriented businesses, and more reliable and relevant financial information was needed by the managers who make decisions about the efficient allocation of their equity. At the same time, China has reached out to the international market to form joint ventures with the world's capital markets. Therefore, there was increasing demand for a framework of accounting standards to meet the needs of investors and creditors as well as management and government (Huang and Xun, 1997, Wang et al., 2005). In order to maintain its legitimacy, ASC has had to conform to generally acceptable accounting standards.
Later, the Chinese Institute of Certified Public Accountants (CICPA) was established in
1988 due to the open-door policy and economic reform program. There was a need for the establishment of a CPA system. Neither the ASC nor the CICPA have authority to set accounting standards. The responsibility for formulating, promulgating and administering accounting regulations falls on the Ministry of Finance (MOF). CICPA is responsible for regulating, governing and monitoring the reform and development of the accounting profession. It has also served as a bridge between the government and practising accountants under the supervision of the MOF (Huang and Xun, 1997). The government issues accounting regulations in China. They are rules and must be strictly adhered to.
MOF engaged Deloitte Touche Tohmatsu as consultants on a three-year project to develop some 30 accounting standards appropriate to China's developing socialist market economy, aimed at bringing accounting and financial reporting practices in
Chapter 4 Historical Context 156
China more into line with those used internationally in 1993. This project was funded by the World Bank. Globalization is identified as an external disturbance to China. In a state of uncertainty, MOF consulted a socially accepted organization, Deloitte Touche
Tohmatsu, to prove its beneficial and legitimate existence.
4. 9 Accounting developments in Hong Kong
The accounting system in Hong Kong is heavily influenced by UK standards and practices, since the British introduced their business philosophies and accounting practice to the colony. As Ernst & Young (1993) observed, Hong Kong SSAP are almost identical to the UK SSAP issued by the former UK Accounting Standard
Committee.
The development of accounting in Hong Kong has “paralleled the growth in public awareness of the importance of financial reporting” (Auyeung, 1997, 285). Before
1960, public corporations were not common. Large organizations such as Jardine
Matheson and Hutchison were private companies. Only a limited number of companies were listed on the stock exchange. Accounting records were considered confidential and secret among family-owned businesses and the view of local sensitivities is generally accepted. “The most widely cited local cultural influence is a reputed tendency of local clients to be reluctant to disclose what they perceive as private information but which in the Anglo-Saxon view is seen as proper disclosure” (Phenix,
1993, 173). Therefore, it is also a common practice to keep separate books for private
Chapter 4 Historical Context 157 and tax purposes (Seiler, 1966). The main users of financial reporting are the tax authority, liquidators and receivers.
There were both mandatory and advisory sources of generally accepted accounting principles (GAAP) in Hong Kong forming the financial reporting framework (Ng,
1997). Mandatory sources were the Companies Ordinance (legal requirements include maintenance of accounting records, content of financial statements, and audits of companies incorporated in HK), Hong Kong Financial Reporting Standards (HKFRs) which are developed by HKSA (now HKICPA), and the Listing Rules, which are set by
SEHK. Other advisory sources of GAAP included the accounting guidelines and accounting bulletins. The key players involved in the development of accounting/banking in Hong Kong included the Company Ordinance, accounting professional bodies such as ACCA, Banking society, Hong Kong Stock Exchange
(HKSE) and the HKMA, which governed that banking sector.
4. 10 Players around the organization
Organizational legitimacy, which is central to institutional theory, can be achieved by means of institutional isomorphism (Deephouse, 1996, DiMaggio and Powell, 1983,
Oliver, 1997, Scott, 2001). People from both inside and outside organizations play an important role in the institutions to which organizations are expected to conform in order to achieve legitimacy.
To understand the way an organization responds to institutional pressures for conformity, we need to understand the social actors who determine that legitimacy, and
Chapter 4 Historical Context 158 to the unique structure, culture and routines which determine organizational response to external expectations, with resulting organizational behaviour. These are the three
“carriers” of institutions which influence the organization. Organizations expected that they would be successful and achieve legitimacy if their culture and practices matched the expectations of the government and society. Changes experienced by the bank over the years have already been referred to, as emanating from both external and internal sources.
4.10.1 Companies Ordinance in Hong Kong
Company Legislation established the primary legal control over financial reporting. The
Companies Ordinance contains, inter alia, provisions relating to financial reporting, such as disclosure requirements, preparation of financial statements and returns, the maintenance of proper books and records, appointment and qualification of auditors, their powers and duties, and the auditor’s report. It is closely modelled on that of the
UK and it is “[A]nother major source of authority in Hong Kong accounting” which
“comes from the Company Ordinance” (Ball et al., 2003, 239). It was first issued in
1865, which is the same year as the establishment of HSBC, and based on the UK
Companies Act of 1862. And subsequent amendments in UK company legislation were followed by corresponding changes in the Hong Kong Statue (Auyeung, 1997, 298).
The Companies Ordinance in 1911 resembled the UK Companies Act 1908 and the
Company Ordinance in 1932 was based on the 1929 UK Companies Act (Auyeung,
1997, Ball et al., 2003).
Chapter 4 Historical Context 159
The Companies (Amendment) Ordinance 1984 in Hong Kong adopted and incorporated provisions from the UK Companies Act 1948. That was a considerable delay, although there were important changes introduced in the UK Companies Act 1948. The Hong
Kong Companies Ordinance did not change until 1984 when the Standing Committee on Company Law Reform was established to regularly review Hong Kong’s corporation legislation. The new law which brought Hong Kong in line with the statutory disclosure requirements in the UK represented a significant stage in mandatory financial reporting. The Companies Ordinance required that accounting information give a “true and fair view” which is consistent with common-law concepts (Ball et al., 2003). It provided not only greater disclosure of information to investors and creditors but also greater protection for shareholders of public companies. HSBC had to respond to this coercive influence to ensure its survival in the long run by conforming to the disclosure requirements in their annual reports.
During the 1990s, a number of minor amendments were made to the Companies
Ordinance. The Companies Ordinance in 1991 permitted a company, if authorized by its
Articles of Association, to purchase its own shares either out of distributable profits or out of the proceeds of a new share issue made for that purpose.
Chapter 4 Historical Context 160
Figure 4-17 Accounting development in Hong Kong time-line
1865 1911 1932 1950 1973 1982 1984 1986 1989 1993 1994 2004
SEHK First Companies Companies ACCA - HKSA Formal Companies HK Security HKSA Accounting Converge to (Accounting Companies Ordinance (HK) - Security standard- (Amendment) & Future adopted standard International Ordinance and reporting Ordinance Ordinance setting Ordinance Commission official Advisory Financial requirements) (Consolidation) structure (SFC) policy - Panel & Reporting introduced IAS Financial standard - GAAP Accounting (IFRS) standard committee
Chapter 4 Historical Context 161
4.10.2 Accounting Professional body in Hong Kong
The economy of Hong Kong became industrialized between 1951-60. During that time, China was under an embargo by the United Nations because of its involvement in the Korean War. Hong Kong benefited from the existence of trade ties since it was the only channel to trade between East and West. The British exported professional accountancy in the 19th century. British cultural influence was strong in the colony. The Association of Chartered Accountants (ACCA) established branches in Hong Kong in January 1950 (Parker, 1994). However, it did not gain its royal charter until 1974.
The accounting profession did not issue any proper statement on accounting or auditing until 1976, and the accounting profession in Hong Kong was regulated by the government’s authorized Auditors Board before 1973 (Auyeung, 1997).
Accountants who were qualified under the Board to audit the accounts of limited companies were called “authorized auditors”. Accounts were kept either in English or in Chinese. They were divided into Part I auditors (permitted to audit English accounts) and Part II auditors (Chinese). HSBC’s auditors statements were written in English.
However, with the rapid growth of the economy in Hong Kong as it developed into a financial centre, changes in corporate financial reporting were needed. Relevant and reliable information for institutional investors was needed for decision making and the demand for higher reporting standards created a demand for better trained professional accountants. The demand for accounting auditing services rapidly
Chapter 4 Historical Context 162 increased because a large number of Chinese partnerships were converted into private limited companies in the early 1970s for the benefit of limited liability.
The accounting system in Hong Kong began to take shape when Hong Kong became a financial centre. Before 1973, accountants in Hong Kong could only become qualified through gaining membership from overseas professional bodies from the
UK and other Commonwealth countries. The Hong Kong Professional Accountants
Ordinance required all members of the profession to have legal and professional status in 1973. The Hong Kong society of Accountants, now the Hong Kong
Institute of Certified Public Accountants (it changed its name in 2004) is empowered by the ordinance to regulate the practice of the accountancy profession, and to issue practising certificates. No discernible change in the profession has occurred since the return of sovereignty to the PRC (Tsui, 1998). The profession began to formulate policies on the education, training and self-regulation of accountants, and the development of standards and services to members, when the first accounting professional body, the Hong Kong Institute of Certified Public Accountants, formerly the Hong Kong Society of Accountants (HKSA), was established in 1973 by the Professional Accountants Ordinances (Chapter 30 of the Laws of Hong
Kong) (Auyeung, 1997, Ball et al., 2003, Tsui, 1998). It was the only statutory licensing body of accountants in Hong Kong responsible for the regulation of the accountancy professional (Hong Kong Institute of Certified Public Accountants,
2005). Accountants practising in Hong Kong were required to register as members of the HKSA and the primary function of HKSA is the registration and supervision of accountants both in the profession and outside public practice. The ordinance
Chapter 4 Historical Context 163 empowered the HKSA to regulate the practice of the accounting professional, to conduct exams and to issue practising certificates (Auyeung, 1997, Tsui, 1998).
HKSA conducted a joint examination scheme with the ACCA. This scheme was an implicit acceptance of the U.K. model by the HKSA. The Statements of Standard
Accounting Practice issued up to 1993 were identical to those issued in the U.K.
Tsui (1998) explained this as a “colonial legacy” since Hong Kong was a British
Colony. HKICPA developed a new professional accreditation system with a professional qualification program which is separated from ACCA. It was implemented from 1999 and the joint examination scheme was phased out in 2001
(Hong Kong Institute of Certified Public Accountants, 1999). It also has its own list of competency standards and requirements.
China’s open-door policy since 1978 has encouraged and diversified industries in both China and Hong Kong. There was rapid growth of the finance sector and the establishment of three new stock exchanges in Hong Kong. Followed by the stockmarket boom and collapse in 1973-1974, there was high demand for quality reporting (Auyeung, 1997). The development of standard-setting was stimulated further by the property crash of 1983 and the collapse of the Carrian Group, with debts of about US$500 million, and fallout with a number of banks. This drew heavy criticism for the profession of accounting, a series of law suits against auditors, and criminal fraud prosecution against directors and auditors (Hong Kong
Institute of Certified Public Accountants, 2004). The effect of the bankruptcy of the
Carrian Group on HSBC’s financial reporting will be further discussed in section
6.2.1.
Chapter 4 Historical Context 164
There was no formal standard setting in Hong Kong until 1982, some years after the equivalent bodies in Malaysia and Singapore, when the HKSA established the
Accounting Standards Committee. This can be interpreted as a mimetic force for
Hong Kong. The HKSA in 1982 consisted of members from CPA firms, industrial and commercial organizations and tertiary education institutions (Auyeung, 1997).
It also had the Joint Examination Scheme with ACCA. Hong Kong Statements of
Standard Accounting Practice (SSAPs) were issued based on the UK standards. The
UK SSAPS were reproduced and used as non-mandatory accounting standards (Ball et al., 2003). According to Ernst & Young , the reason for the imitation of the UK standards is that a number of the HKSA’s members during the period were trained in the UK. The accounting practices and audit procedures adopted in Hong Kong therefore reflected the influence of UK accounting bodies.
The increasing globalization of business and the expansion of foreign operations during the 1980s caused the professions to recognize the importance of international accounting standards. The Sino-British Joint Declaration was signed in 1984 and the Enactment of the Companies (Amendment) Ordinance was established. The crisis of confidence in the future of Hong Kong was sparked by the relocation of domicile by formerly Hong Kong-based companies, such as HSBC, which moved its headquarters to London in 1990.
The switch to IASs was accelerated because it was perceived by the market as a form of insurance against expropriation by a post-1997 Government. At the same time, a lot of companies chose to follow international standards and/or the accounting standards of the jurisdiction of their new domicile. For example, HSBC,
Chapter 4 Historical Context 165 with the approval of the SEHK, adopted the UK Companies Act, Jardine Matheson, the IASs (Auyeung, 1997). Hong Kong standards based on the UK contain less accounting options. The profession therefore began to revise its standards to conform with international standards and improve financial statement comparability.
Hong Kong can ensure that its standards are consistent with the International
Accounting Standards because it closely follows the UK standards which complied with corresponding International Accounting Standards. As the UK standards became increasingly influenced by the issue of harmonization within the European
Union, and with the growing business ties between Hong Kong and China, HKSA started to shift to International Accounting Standards (IASC) for future guidance.
According to Price Waterhouse (1991) the Hong Kong SSAPs comply in all material respects with the applicable International Accounting Standards Committee (IASC) statements. Large organizations have adopted IASs to reflect their own increasing international nature. Moreover, with the increasing importance of PRC-based corporations and PRC investment in HK, there is an urge to switch to IASs. HKSA officially switched to IASs as models for future accounting standards and guidelines in 2001 (Ball et al., 2003). Ho (1998) commented that the enforcement of, and compliance with, the compulsory accounting and reporting standards in Hong Kong is at a satisfactory level. It allowed foreign companies to comply with either Hong
Kong GAAP or IASs before the switch to IASs. Hong Kong is therefore more in line with the international standards than China.
“It has become common for multinational companies to express their accounting results by reference to an internationally accepted approach. This has been
Chapter 4 Historical Context 166 perceived as being more acceptable to the investing public and to stock exchange regulators. At present, many companies have two internationally recognized approaches from which to choose – US GAAP and IRFS” (Roberts et al., 2005, 37).
“In some cases, national requirements conform with IFRS. In such instances there may be no practical problem from the point of view of the company but it is important for the user of the financial statements to know that this is the case”
(Roberts et al, 2005, 39). HSBC belongs to this group.
4.10.3 The Exchange Banks’ Association (EBA)
British bankers and the elite in business conglomerates formed the banking policy network in colonial Hong Kong. They formed the base of legitimacy in reasoning for policy formulation and policy outcomes. The power of the British banks and
British culture was embedded in the early regulatory framework of the banking industry in Hong Kong. In the early colonial period of Hong Kong, the government had a laissez-faire and non-interventionist policy governing the banking industry.
All banking disputes could be related to the common law and the Colonial Banking
Regulations which applied to all British colonies (Ghose, 1995). The first
Companies Ordinance was enacted in 1865 and embraced all kinds of companies including banks. The first local ordinance governing the banking industry was not enacted until 1948, with the official definition of ‘banking business’46 (Beecham,
1998, Hong Kong Institute of Bankers, 1999, Hsu, 1998).
46 The ordinance regulated all the licensing and incorporation of banks, note-issuing, banking business, and submission of annual accounting statements. Banking business was defined as the receipt of money on current or deposit account or in payment and collection of cheques drawn by or paid in by a customer in purchase and sale of gold or silver coin or bullion.
Chapter 4 Historical Context 167
The Association was established by a group of British banks in 1897 and represented all banks in the colony. The group of British banks included HSBC, the
Chartered Bank, and the Mercantile Bank. The major functions of EBA included making rules and codes of practice in the banking industry, acting as a forum for bankers for fixing agreed foreign exchange rates, and acting as an advisory body for the government in financial matters. However, it had no statutory power (Ghose,
1987). The chairmanship of EBA was occupied alternatively by HSBC and the
Standard Chartered Bank. Majority members in the executive committee were
British banks. Chinese local banks, such the Bank of East Asia and the Bank of
China, were a minority in the committee. The suggestions given to the government on banking reform by the EBA had a bias in favour of the British banks’ interest
(Chan, 2002). The Interest Rate Agreement was established by the Association in
1964 with the consent of the government. EBA was superseded by the Hong Kong
Association of Banks by statute in 1981.
4.10.4 Hong Kong Association of Banks (HKAB)
The Hong Kong Association of Banks was created by the Hong Kong Association of
Banks Ordinance in 1981 to replace the Exchange Banks’ Association as the representative organization of the banking industry in Hong Kong (Hong Kong
Association of Banks, 2007). According to the bank ordinance, all licensed banks operating in Hong Kong had to be a member of HKAB and subject to HKAB’s rules. The ordinance also provides a framework for the Government to exchange views with the banking sector for the further development of the industry. HSBC and Standard Chartered Bank shared the chairmanship of the HKAB, on a two-year rotating basis(Hong Kong Association of Banks, 2007). The HKAB has a specific
Chapter 4 Historical Context 168 role in the administration of the interest rate agreement which regulates the maximum rate of interest paid by licensed banks for term deposits with a maturity of not more than 12 months. It also operates the Bankers Clearing House.
The interest rate agreement was revised in 1982 and licensed banks were not subject to the agreement on interest rates. There was no legislative control over the establishment of branches before 1967. The banking Ordinance in 1967 required banks to obtain prior approval from the Banking Commissioner for the opening of branches.
The banking crisis in 1965 led to the liquidation of a number of local Chinese banks
(including Hang Seng Bank which was acquired by HSBC). According to the bank’s annual report in 1981, the creation of the new association formalized government’s consultative role in the determination of deposit interest rates. It also constituted the first step in a move by the government to update legislation affecting the financial sector generally. HSBC was the Chair of the Committee, the highest executive body of HKAB, which directs and decides the business and policies of the
Association. The bank is also the Chair of the Consultative Council which advises the Committee on matters relating to the business of banking and also acts as a body for two-way communication between member banks and the Committee. The Bank of China and the Standard Chartered Bank (both are note-issuing banks) are the
Vice-Chairmen of the Committee and the Consultative Council.
4.10.5 Bank Ordinance/Legislation
HSBC is subject to the provisions of the Banking Ordinance of Hong Kong (Chapter
155) and its duties and functions ascribed by the HKMA. HKMA was established
Chapter 4 Historical Context 169 by combining the Exchange Fund47 Office with the commissioner of the Banking
Office. The major function of HKMA was to promote the stability and effectiveness of the banking system in preparation for the transition to Chinese sovereignty in
1997. It was responsible for supervising compliance with the provisions of the
Banking Ordinance which gives power to the Chief Executive of Hong Kong to give directions to the HKMA and the Financial Secretary with respect to the exercise of their respective functions under the Banking Ordinance. It was regarded as the de facto central bank of Hong Kong. It performed functions such as the conduct of monetary policy, lender of last resort, provision of clearing, and prudential supervision of banks (Jao, 2003, Yam, 1994). However, the issue of legal tender notes is still in the hands of HSBC, Standard Chartered Bank, and Bank of China48
(after 1994). Commercial banks and other depository institutions are not required to keep non-interest-bearing reserves with HKMA. A positive balance in their clearing accounts is sufficient. Most importantly, HKMA cannot conduct monetary policy independently of the Federal Reserve System of the United States as a de facto central bank (Jao, 1990, 1998, 2003). HKMA also prescribed that financial information be reported periodically to it and listed accounting and reporting requirements for the general purpose financial statements of banks.
Chen Yuan, the deputy governor of the People’s Bank of China (PBC), the central bank of China, enunciated to an international audience several principles that would govern the financial relationship between Mainland China and Hong Kong after
47 The Exchange Fund was set up in 1938 when Hong Kong abandoned the silver standard and opted for the sterling exchange standard. It was enlarged to include not only foreign exchange reserves but also the government’s fiscal surplus. 48 The Bank of China became the third note-issuing bank in 1994.
Chapter 4 Historical Context 170 reunification in 1996. The currencies and monetary systems and the two monetary authorities (PBC and HKMA) of China and Hong Kong will be mutually independent of each other. The PBC will not set up any office in Hong Kong and will support currency stability in Hong Kong (Chen, 1996, Jao, 2003).
Before the establishment of HKMA, all licensed banks were required to keep a clearing account direct with HSBC. HKMA took over the central-clearing function.
HSBC attracted some adverse comment on its role as a de facto central bank (Jao,
1998). HKMA also took over the role of the lender of last resort from the two
British banks. The Exchange Fund had not published a balance sheet since 1940.
HKMA published all financial accounts of the Exchange fund on an annual basis, and subsequently on a monthly basis. It provided greater openness and transparency to the public.
HKMA will conduct ‘on site’ examinations of banks in Hong Kong. It requires all authorized financial institutions to have adequate systems of internal control and their external auditors to report on those systems.
The Banking Ordinance required that banks submit to the HKMA certain returns and information, and established minimum standards and a ratio with which banks must comply, such as capital adequacy, liquidity, capitalisations, and limitations on shareholdings. Hong Kong implemented the capital adequacy standards set up by the Basel Accord in 1989. Currently, banks in Hong Kong must maintain at least
8% capital adequacy ratio (capital base to its risk-weighted exposure) (The
Hongkong and Shanghai Banking Corporation Limited, 2005, 21-22).
Chapter 4 Historical Context 171
4.10.6 Stock Exchange requirements
As a listed company in Hong Kong, HSBC also has to comply with the Stock
Exchange financial reporting requirements. The Stock Exchange is a secondary source of accounting regulation. The stock market has been an important source of capital funds for business since 1969 although formal stock-trading activities began in 1891 with the establishment of the Hong Kong Stock Exchange. Public corporations were not common until the late 1960s and most firms started as sole- proprietors during the industrialization of the early 1950s. The present Hong Kong
Stock Exchange Ltd was formed in 1947 by the merger of the previous Stock
Exchange and the Hong Kong Sharebrokers’ Association, which was formed in
1921 (Schenk, 2003, Wong, 1986).
The banking crisis in 1965 was due to overspeculation by some banks in respect of the government’s announcement of a new scheme for partial control over the electricity supply companies. Share prices fell very suddenly and severely because some banks called in loans secured by quoted shares and others disposed of their own shareholdings. Also, the unstable political situation in China, with the activities of the Red Guards, held share prices at a low level in 1966. During 1967 share prices fell to their lowest point since 1961. This was due to the political disturbances which occurred in Hong Kong. During the disturbances, the Hong
Kong Stock Exchange suspended operations twice to prevent panic selling (Schenk,
2004b). The uncertainty over Hong Kong’s future restricted the development of the stock market by discouraging equity investment.
Chapter 4 Historical Context 172
There was a major boom in the stock market during the period 1969 to 1973. Wong
(1986) commented that this was due to the restoration of business confidence after the political disturbance of 1967; the extreme liquidity of the banking sector because of an inflow of overseas funds from the international currency crisis; the sharp fall of share prices on the New York stock market which encouraged local and Southeast
Asian funds to turn to Hong Kong; and the repeated indications by China that Hong
Kong was not regarded as a priority issue, but as an issue to be dealt with when the time was ripe. This enabled Hong Kong to measure its future in decades rather than years.
During this period, there was a rush of new companies seeking quotation on the stock exchanges. Wardley Limited, a wholly owned subsidiary of HSBC, was among the banks which were established to underwrite and handle the flotation of new issues. A slump of the stock market during 1973-74 occurred after the great boom. It was mainly caused by the discovery of forged share certificates in certain companies. It was worsened by the introduction of a profit tax on stock-trading, rent control imposed by the Government and the tightening of credit conditions. The
Hang Seng Index fell by 409.7 by the end of 1973, from 843.4 to 409.7 (Schenk,
2004b). Things were made even worse by the international oil crisis and economic stagnation in 1974.
The property market collapsed in the second half of 1982, which brought the Hang
Seng Index down by about 40%. Uncertainty about the future of Hong Kong and the worldwide recession once again contributed to the fall in the share market. A number of finance companies and property groups became insolvent. The Hang
Chapter 4 Historical Context 173
Seng Index crashed to 676.3 by the end of 1982 when Mrs. Margaret Thatcher made her first visit to Beijing to discuss the future of Hong Kong after the expiry of the lease of the New Territories in 1997. The fall was caused by the slow progress of the negotiations between the British and Chinese Governments. Hong Kong people lost further confidence in the future of Hong Kong. The index rose again from
874.9 in 1983 to 1200.4 in 1984 when more concrete proposals were put forward to maintain the stability and prosperity of Hong Kong after the handover (Mulcahy,
1984, South China Morning Post, 1984).
The Hong Kong Government established the Securities and Futures Commission in
1989 to supervise securities markets. The Hong Kong Securities and Futures
Commission and Stock Exchange of Hong Kong signed a Memorandum of
Regulatory Cooperation with the China Securities Regulatory Commission,
Shanghai Securities Exchange and Shenzhen Stock Exchange to facilitate cooperation regarding cross-listed securities in Hong Kong and China. This memorandum mainly responded to the listing of Chinese stocks (red chips) in Hong
Kong, which provided limited regulation and disclosure.
The government tightened regulations and increased intervention following the financial crisis due to speculative attacks on the Hong Kong dollar in 1997 and
1998. Exchange Investment Limited, which managed the portfolio, started selling two thirds of the portfolio through a mutual fund. The remaining one third was retained as a long-term investment to defend the Hong Kong dollar from further attacks (Ghose, 1995). The securities Review Committee in 1998 introduced tightened and rationaliz generalized perception of assumption that actions ed
Chapter 4 Historical Context 174 regulations to enable Hong Kong to deflect speculative attacks on its currency via the stock and futures markets. For example, large securities purchasers must provide information about their identity to the securities traders.
HSBC is one of the constituent stocks of the Hang Seng Index (HSI). The HSI currently comprises 33 constituent stocks which represent the market. The aggregate market capitalization of these stocks accounts for about 70% of the total market capitalization of all eligible stocks listed on the Stock Exchange of Hong
Kong (Hang Seng Indexes Company Limited, 2000).
The Stock Exchange is operated by The Stock Exchange of Hong Kong Ltd
(SEHK), a company organized under the Companies Ordinance and authorized by the government as the sole market for share trading in Hong Kong. It was formed in
1986 from the amalgamation of four pre-existing exchanges and has 928 ‘seats’
(shares) held by 586 member firms. Following the 1987 October stock market crash
(which was often referred to as the Asian financial crisis) and the SEHK’s closure for four days, it was reorganized and the government set up the Securities Review
Committee headed by UK accountant Ian Hay Davison (Winn, 1987). The primary brief of the SRC was to investigate the causes and effects of the crash, the SEHK closure and the collapse of the Hong Kong Futures Exchange, which at the time was the third largest in the world.
Listed companies are required to comply with and satisfy the Listing Rules and the accounting and reporting requirements of the SEHK. They have to “prepare annual financial statements in compliance with the requirements of the Companies
Ordinance and additional disclosure relating to real property and segmental
Chapter 4 Historical Context 175 information” (Auyeung, 1997, 299). The SEHK also issued recommendations on more detailed disclosures in the financial statements of both listed and non-listed financial institutions in conjunction with the HKMA and the Securities and Futures
Commission. “The financial reporting standards in HK are substantially in line with those of other major financial centres” (Auyeung, 1997, 299).
To sum up
This chapter concentrated on the historical influences of the bank’s founder, Thomas
Sutherland, who established the unique culture of the HSBC, by describing its historical roots in Hong Kong, outlining significant issues in its current social and economic environment, and introducing HSBC as it operates in Hong Kong today, based on its distinct culture, financial status, and the responses of the general public.
HSBC also has to conform with the external coercive pressures from the organizations around it in order to survive. For example, pressures such as the
Company Ordinance, the accounting standards set by the accounting professional body, the Hong Kong Association of Banks’ rules, the banking ordinance of Hong
Kong, and the stock exchange requirements.
HSBC has always tried to balance both the East and West through all its historical developments. It has always tried to keep the Scottish tradition, supporting the
British Empire and British trade, while also being a local bank in Hong Kong.
HSBC has also tried to deal with China behind the scenes and to seek opportunities.
It has been argued that the theme of this study is “one bank, two cultural identities”, which is in line with “one country, two systems”. This chapter has provided two types of analysis. Western analysis through the legislation, the Banking Ordinances,
Chapter 4 Historical Context 176 and the Companies Act. These are abstract constructions, but then there are physical constructions in terms of the building and feng shui, and imprints of culture.
The following three chapters, Chapters five, six and seven, will explore how HSBC incorporated all the expectations of these players in its annual reports.
Chapter 5 Accounting in HSBC 1967 - 1979 177
CHAPTER 5 ACCOUNTING IN HSBC 1967-1979
This chapter specifically focuses on the accounting practices of HSBC between
1967 and 1979. This builds on the discussion in chapter four which identified the key players who affected the financial reporting of HSBC. This chapter describes the details of accounting changes in the annual reports of the bank and how the bank uses its financial reports to achieve legitimacy in the eyes of the financial sector, customers, the Hong Kong government and the public. Over this and the next two chapters, analysis of HSBC’s annual reports will be divided into three phases. The first phase is 1967-1979. It was in 1967 that major radical political and social change started in Hong Kong. HSBC had to project itself as a safe and sound financial institution in order to survive. The second phase was 1980-1996, which is discussed in chapter six. HSBC acquired a major bank in the US, which affected the reporting style and methods of the bank because of the impact of international accounting standards. Specifically, the disclosure practices of inner reserves proved pivotal to HSBC’s financial reporting. The last phase, 1997-2004, is discussed in
Chapter seven. HSBC had to comply with the reporting regulation while at the same time decoupling its Western image from it after 1997.
Section 5.1 discusses accounting as an institutional element. Section 5.2 discusses the disturbances that affected the bank’s financial reports during 1967-1979. These disturbances included the banking crisis before 1967 and the acquisition of the Heng
Sang Bank, the devaluation of silver, and the acquisition of an American bank, the
Marine Midland Banks Corporations (MMBI). This is followed by general observations about the annual reports during the period in Section 5. 3. Accounting
Chapter 5 Accounting in HSBC 1967 - 1979 178 changes in the financial reporting of HSBC because of these disturbances can be seen from the notes on accounts, HSBC’s disclosure, and its revaluation of accounts.
A capital problem emerged for the bank after the acquisition of MMBI, and the accounting procedure for the acquisition will be discussed in Section 5. 4 and
Section 5. 5 respectively.
The chapter will concentrate discussion on the first phase (1967-1979) of HSBC’s life that is being studied – the period before the major external environmental disturbances, discussions between the British and Chinese Governments about the handover of Hong Kong to China, which impacted on the bank.
5. 1 Accounting as an institutional element
Emphasis has been placed on how, in the light of accounting’s various contexts, accounting history needs to address concerns not previously considered by academic accountants (Parker and Yamey, 1994). For example, Hopwood et al. (1985) analysed value-added statements from the point of view of social context rather than accounting techniques. Parker and Yamey (1994) also observed that the history of accounting needs to be explained in cultural as well as economic terms.
Traditionally, financial statements have been projected to the public as “true and fair” and objective. The purpose of externally reported financial statements is to provide financial information about an organization to its investors and lenders. It was provided under the financial reporting standards and generally accepted accounting principles (GAAP) which have been developed mainly for the primary audience: owner-investors and lenders. Financial statements provided vital information about the profit or loss performance, financial condition and cash flows
Chapter 5 Accounting in HSBC 1967 - 1979 179 of an organization. Financial statements are important and can be used as an analytical tool, an early warning signal, a basis for prediction, and a measure of accountability (Revsine et al., 2005, Stickney et al., 2007). Banks operate in an environment and are subject to political and social as well as economic pressures.
They have goals and employ strategies to attain those goals in the environment in which they operate. The goal is profit and financial survival. Ratio analysis is a well-established tool to evaluate an organization’s liquidity, profitability and financial stability, and provide information for decision making (Gaffikin, 1993,
Hoggett et al., 2006).
However, financial reporting is related to the construction and reproduction of the social world and it is not only serving its functional and technical objectives (Hines,
1995). Financial statements can be manipulated arithmetically because they involve calculating numbers which “mirror the concrete structure of social reality” to describe economic events (Hines, 1995, 276). Financial accounting and reporting construct the “truth” about organizations. They “presume, legitimize and reproduce the assumption of an objective world” and also constitute the social world (Hines,
1995, p.288). Therefore, they could provide social legitimacy to the accounting profession. Legitimacy is achieved by the assumption of objectivity in preparing the financial reports. Accountants have power and privileged access through their measurement expertise leading to the construction of legitimacy and professional power. Institutional theory therefore provides a way to understand the symbolic role of accounting information in financial reporting. This chapter begins one of three chapters undertaking this analysis in the research site of HSBC.
Chapter 5 Accounting in HSBC 1967 - 1979 180
5. 2 Disturbances
Organizational change can be understood by tracing the pathway where disturbances took place. These disturbances triggered alternative organizational ‘transitions’ and
‘transformations’ (Laughlin, 1991). HSBC had gone through a number of disturbances which affected financial reporting (refer to Figure 5-1). These disturbances between 1967 and 1979 were the acquisition of the largest local
Chinese bank, the Hang Seng Bank, devaluation of the sterling, and the acquisition of the MMBI in the late 1960s. Two of these disturbances were self-imposed (the acquisitions), whereas the devaluation of sterling was external and not controllable.
The bank had to respond to these disturbances by changing its financial reporting and the language of accounting became the vehicle for HSBC’s organizational change.
Figure 5-1 Summary of disturbances Disturbances between 1967 and 1979
1.. Acquisition of Heng Sang Bank
2. Devaluation of sterling
3. Acquisition of Marine Midland Banks Incorporated (MMBI)
5.2.1 Disturbances before 1967 – acquisition of Hang Seng Bank
Coercive forces can be seen from the changes in accounting practice demonstrated in HSBC’s financial reports. The Banking Ordinance was amended in 1967 to tighten up the regulation in order to reinforce local confidence in the banking system, which was affected by the bank runs and the unrest in China (The
Hongkong and Shanghai Banking Corporation, 1968). HSBC needed to satisfy the
Chapter 5 Accounting in HSBC 1967 - 1979 181 financial reporting requirements, which reflected coercive institutional pressure exercised by the government. There were no legal requirements to report on the liquidity ratio and capital adequacy ratio in the early 1960s. The stock market and property market boomed and speculation was on the rise. Some local banks started to offer higher interest on deposits in order to attract funds, and at the same time gave easier terms to borrowers in order to increase their lending portfolio. HSBC and Standard Chartered Bank became the sole suppliers of funds to those smaller banks so that they could meet the short-term demand in the inter-bank market.
These “British banks” gained profits from charging the smaller local banks a high interest rate. This was constitutive of bank runs and part of the social construction of the lack of confidence in the mid-1960s.
The first requirement to disclose the liquidity ratio and minimum capital adequacy ratio was set in the Banking Ordinance 1964 after a bank run started on Liu Chong
Hing Bank49, resulting in massive withdrawals. The ordinance targeted the small to medium banks’ overly risky loan portfolios. However, this new legislation did not have enough time to have any positive effect on the banking system before the bank runs in 1965. The property market continued to boom in the mid-1960s. The average liquidity of the banking system in Hong Kong decreased from 53.3% in
1954 to 27.6% in 1964 because most banks were overexposed in the medium-term property market (Jao, 1974). Smaller local banks offered higher interest rates on deposits than the British banks, which had a better reputation and lent at a higher rate to more risky customers. The entire banking system was vulnerable when there
49 Liu Chong Hing Bank was a local bank. Around HK$30 million was withdrawn by panicked depositors in three days when there was a rumour about the chairman of the bank (Ghose, 1995).
Chapter 5 Accounting in HSBC 1967 - 1979 182 were periodic downturns in the business cycle of the property market. The bank run hit small local banks50 in late 1965. Rumours and the ‘herd effect’ of depositors led to runs on several medium-sized local banks51, including Hang Seng Bank Ltd, which was later acquired by HSBC.
HSBC’s market position was raised after it acquired 51% of the largest local
Chinese bank, the Hang Seng Bank Ltd, in April 1965. Since the financial position of the Hang Seng Bank was fundamentally sound with a good composition of assets
(total assets of HK$761 million), and because it had many branches before the run, the acquisition was favourable to HSBC (Chan, 2002, Fung, 1997, Jao, 1974). Also the “rescuing” of local banks gave HSBC’s public a high degree of confidence. The bank also became the largest retailing banking group in Hong Kong. After the banking crisis of 1965-66, the government issued an amendment of the Banking
Ordinance in 1967 which was designed to raise the general capital level and liquidity of banks, and better surveillance on the account management of banks.
Under the Amended Ordinance, the Commissioner required the monthly returns to be verified by an external auditor and the Commissioner could appoint a second auditor in certain cases (Ghose, 1995). At the same time, there was no new licence issued during 1967-77.
50 Ming Tak Bank, Canton Trust and Commercial Bank Ltd. 51 Kwong On Bank Ltd., Dao Heng Bank Ltd., Far East Bank Ltd., and Wing Lung Bank Ltd.
Chapter 5 Accounting in HSBC 1967 - 1979 183
Moreover, because of the riots in Hong Kong caused by the Red Guard52 disturbances occurring on the mainland, the public preferred to hold banknotes rather than bank deposits, which caused a 35% rise in the currency in circulation.
The pro-communist leftists in Hong Kong, in particular the Hong Kong Federation of Trade Unions who were inspired by the Cultural Revolution in China and had strong ties to the Chinese Government, turned a labour dispute into a large-scale demonstration and strike against British colonial rule. These riots turned to violence and many were killed, including police and some protestors. Therefore, the Hong
Kong Chinese lost their confidence in Hong Kong during that time (Scott, 1989, Yu,
1997). HSBC’s loans and advances to commerce and industry levelled, due to the reduction in activity by the Communist banks as a result of the decline in imports from China. The expansion of the note issue resulted in a drawdown of interest- bearing funds in London. During 1967 (the Red Guard period), loans increased at the cost of liquidity. The bank had survived, with its loans increasing from
HK$2,682 million to HK$3,058.4 million. However, this increased loan amount was at the cost of liquidity. Liquidity decreased from 36.3% to 35.7 in 1968 (refer to Figure 5-2). The Chairman’s International survey53 contained one full page describing what had happened in China because of the Cultural Revolution. The
Chairman commented that the incident “has reached a climax at the end of 1966 when it began increasingly to involve industrial workers and peasants. It is doubtful
52 The Chinese Red Guards were formed by Mao to combat supposedly ‘revisionist’ elements within the Community Party who opposed him. Massive demonstrations were held in Beijing in 1966, and the numbers of Red Guards swelled to around 11 million. Their activities became ever more zealous and violent, involving widespread persecution and murder of any person suspected of being ‘bourgeois’. In-fighting and growing economic disruption led Mao and the People's Liberation Army to suppress the Red Guards by the end of the 1960s. 53 International survey is a section of HSBC’s annual report which described their operations over the world.
Chapter 5 Accounting in HSBC 1967 - 1979 184 if this was originally intended. The use of student Red Guards was expected to be enough to overthrow the Party ‘power-holders’, who, however, proved to be well entrenched” (The Hongkong and Shanghai Banking Corporation, 1968, 8).
Figure 5-2 Liquidity Ratio 1967-1979
Liquidity Ratio 1967 - 1979
70.00%
60.00%
50.00%
40.00%
30.00% Percentage
20.00%
10.00%
0.00% 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 Year
5.2.2 Devaluation of Sterling in 1967
Later, on 18th November 1967, there was a serious devaluation of sterling (Schenk,
2002). HSBC was a sterling area authorized bank54 which held the bulk of its reserves in sterling as required, and the bank’s business was within the sterling area and held more than 360 million pounds in London (The Hongkong and Shanghai
Banking Corporation, 1968). For the first time as a colonial territory, the Hong
Kong government, on a de facto sterling exchange standard, was given the opportunity to decide its own monetary future. The Hong Kong government was given only four hours’ notice by the British Government to choose whether to devalue or not. The British Treasury refused to give Hong Kong more privileged
54 The British colonial monetary system had been designed to lend colonial currencies the stability of sterling in imperial trade with Britain in the 1960s. Hong Kong was one of the British colonies which offered exchange guarantees for sterling.
Chapter 5 Accounting in HSBC 1967 - 1979 185 treatment than other independent countries, and therefore Hong Kong did not receive adequate notice about the decision to devalue (Schenk, 2004a). As part of the Hong Kong Government’s financial consultation process , HSBC participated in making the decision. The Chairman in his statement blamed the devaluation of sterling and the foreign exchange on the fact that the British Government misjudged world opinion, also stating there was a “failure of the British Government to measure up to its worldwide responsibilities and to maintain the strength of the pound sterling” (The Hongkong and Shanghai Banking Corporation, 1968, 39). He was also angry about the British government’s reaction to Hong Kong liquidating all of its official sterling assets at once.
The riots in Hong Kong and the devaluation of sterling resulted in a decrease of
HK$8.6 million in HSBC’s profit (The Hongkong and Shanghai Banking
Corporation, 1968). The losses resulting from the devaluation of sterling were not included in the figure as reported in 1967. A substantial reason for this was that the extent of the loss was still being negotiated with the government and there was difficulty in assessing the full amount involved (The Hongkong and Shanghai
Banking Corporation, 1968). HSBC appealed to the government for support because this problem arose from its duties as the main note-issuer for the colony and its obligation to hold Sterling for reserve (Schenk, 2004a). The Hong Kong
Government compensated the bank on an ex gratia basis for the loss; however, it was still a $25.6 million loss (Schenk, 2004a). Therefore, the bank chose to absorb the loss by drawing down from inner reserves (discussed in section 5.3.2) and declared the final dividend. Even the bank was expected to sustain a great loss because of the devaluation of sterling, and it was the first time the bank had
Chapter 5 Accounting in HSBC 1967 - 1979 186 published a decline in profits since the Pacific War. It was a general practice of
British and Scottish banks to keep a secret inner reserve account to smooth their profit.
In the next year, the pound sterling was strengthened by the cooperation of central bankers and by measures which guaranteed governments in the sterling area that their official holdings of sterling in London would suffer little loss in the event of a future devaluation of sterling against the US dollar. The Hong Kong government had offered commercial banks valuable exchange cover. All banks were guaranteed against losses on their sterling holdings in the event of a change in the rate of the
Hong Kong dollar against sterling, with a fee. The government compensated HSBC with HK$82.8 million (£5.7 million) after it claimed for HK$86.6 million (Schenk,
2004a). The Chairman of HSBC, Mr. Saunders, commented that the success of these negotiations demonstrated both the ability of the financial authorities, and the independent strength of the dollar and the economy generally (The Hongkong and
Shanghai Banking Corporation, 1969).
At the beginning, bankers among the Executive Council, including HSBC, wanted to maintain parity to avoid losses on their uncovered position in the Hong Kong dollar, while Chinese and some official members wanted to change parity in order to minimize the inflationary impact of higher costs of imported goods. Saunders of
HSBC was particularly angry and challenged the British Treasury about the UK reaction to HK liquidating all of its official sterling assets at once. He therefore proposed a guarantee of 60% of sterling reserves in return for some form of commercial premium to be paid by Hong Kong (Schenk, 2004a). The British
Chapter 5 Accounting in HSBC 1967 - 1979 187 government refused at first, but because of the bank’s influence and many unofficial members of the Legislative Council members threatening to resign, Hong Kong was allowed to diversify a quarter of the existing balances. The bank commented that if no diversification of official reserves was allowed, other banks in Hong Kong would lose confidence in their government’s ability to compensate them for a future devaluation. After the long negotiation, the holdings of all commercial banks in
London were protected and there was a special arrangement to cover up to £150 million of the reserves held in London (Schenk, 2004a, Tang, 1968).
Institutional theory helps us to understand the banking section, but its contribution is limited in explaining these circumstances. By using my framework, drawing on
Laughlin’s Organizational Change Model, we can enhance Institutional theory from a theoretical perceptive and explain this circumstance. When HSBC was facing the disturbances of devaluation of sterling, which affected its legitimacy, rather than passive submission towards this coercive force, it first responded by resisting the change/disturbance. However, with all attempts failing, it had to comply with the government’s decision. Under these rebuttal changes, HSBC tried to accommodate the effects of external disturbances only to a limited extent, and allow meagre changes only in their ‘design archetypes’ (Laughlin, 1991). Although Hong Kong had devalued Sterling, the bank received the most compensation and was offered exchange guarantees by Britain.
5.2.3 Acquisition of Marine Midland Banks Incorporated (MMBI)
To expand globally, the bank had to acquire a stake in a large existing American financial institution, MMBI. MMBI was a leading regional bank in New York.
Chapter 5 Accounting in HSBC 1967 - 1979 188
MMBI ran into difficulties because of its exposure to Real Estate Investment Trust loans made by leasing and mortgage subsidiaries, and to lending by a London merchant bank subsidiary in 1975. It had a serious capital problem with a very low capital to assets ratio of approximately 3% (King, 1991). To save itself and protect its international reputation, the bank had to inject new capital. HSBC became their first priority for partnership because they believed that HSBC had the same culture and values. The Chief executive and chairman of the board of MMBI, Edward W.
Duffy, confessed in an interview after the acquisition that they did not know much about the bank, “other than the fact that [HSBC] had a Tiffany name and good people managing them” (King, 1991, 790). Therefore, the image of the bank became a critical consideration for the director of MMBI. The Chairman strongly emphasized that the bank would not lessen its commitment to Hong Kong and that
HSBC was still a Hong Kong company (The Hongkong and Shanghai Banking
Corporation, 1988, 4).
HSBC took a 51% interest in MMBI in 1980, which led to full ownership in 1987.
The acquisition of MMBI not only affected the structure of HSBC, but also the financial reporting of the bank. This was because HSBC was using British as well as Hong Kong accounting standards. They were not drawn according to the
Generally Accepted Accounting Principle of the Americans. This gave rise to specific accounting issues, especially with respect to accounting for the inner reserve. This will be discussed in section 5.3.2.
Chapter 5 Accounting in HSBC 1967 - 1979 189
5. 3 Annual reports of HSBC 1967-1979
The bank’s published financial statements during 1967-1979 were simple summaries of figures, produced on a semi-annual basis. The balance sheet simply listed all assets in order of realizability and liabilities in order of priority of repayment. There were no classifications and no corresponding period figures. HSBC had to earn a general perception of ‘legitimate’ existence from the society. Therefore it followed generally accepted practice and listed its assets and liabilities without the major asset and liability headings which would appear in the financial statements of non- banking organizations. It was a general practice for the bank to have an inner reserve account which was not fully disclosed to public. This can be referred to as mimetic. There were no detailed notes to the accounts except to the reserve fund.
Lee (1983, p.78) commented that HSBC has been “allowed legally to ‘smooth’ their financial results by use of techniques such as ‘inner’ or ‘hidden’ reserves and to disclose far less information than is expected or required for other trading concerns”.
The main reason was that they wanted to reflect financial stability in the banks for the benefit of depositors and investors, and for their own private benefit.
Annual reports of HSBC included the Chairman’s International Survey which generally summarized the operations during the year. The Chairman also gave a summary for each individual country where HSBC operated. For example, during
1967-1979, Hong Kong, China, Japan, The Philippines, Thailand, Vietnam,
Malaysia, Singapore, Indonesia, Brunei, India, Sri Lanka, and Mauritius were the main countries where the bank operated. These countries were mainly in Southeast
Asia. There were also three to four pages of the Chairman’s statement about the profitability of the current situation, and future prospects of the bank, and an
Chapter 5 Accounting in HSBC 1967 - 1979 190 introduction to the annual report. The International Survey and the Chairman’s report occupied most of the annual report (refer to Figure 5–3). However, changes to the annual report were evident from 1967 onwards.
Figure 5-3 Total number of pages in annual report 1967-1979
Total number of pages in annual report 1967 - 1979
80
70
60
50 Other information
40 Notes on account
No. of Pages 30
20 Balance sheet and Profit 10 and Loss account
0 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 Year
There were significant changes in both the information in and format of the published accounts. There were also changes in accounting practices. Additional information was required by the Hong Kong Companies Ordinance, the London
Stock Exchange, and the British Companies Act. Hong Kong specialized in the syndication of loans to Asia because it had a closer connection with New York and
London, and tax advantages over neighbouring countries. Because Hong Kong did not have a central bank at this time, self-regulation of financial institutions was important. The government undertook a vain attempt to control domestic inflation by taking its banks more firmly in hand (Macesich, 2000).
Changes were noted from time to time in the bank’s annual reports. Accounting changes were of sufficient impact to affect the published rate of growth, particularly as between various key years. The practice of allocating the additional amount
Chapter 5 Accounting in HSBC 1967 - 1979 191 consequent to accounting changes to inner reserves and returning the rough equivalent as a transfer to published reserves no long exist. The main changes included the number of notes on accounts, which is discussed in Section 5.3.1, inner reserves accounts, Section 5.3.2, handling of property and of investment in subsidiaries, Section 5.3.3, and audit reports, Section 5.3.4.
5.3.1 Notes on accounts
From 1967-1974, there was only one page of notes on account as an explanation of the balance sheet and profit and loss account. From 1975 onwards, the number of notes on accounts increased from one to three pages. This was due to the audit requirement of the Hong Kong Companies Ordinance to provide further information as agreed with the London Stock Exchange. For example, some holdings of the bank which were previously included as quoted and unquoted investments in the balance sheet were now shown as Fixed Assets. This was because the Companies
Ordinance interpreted an associated company as one in which more than 20% of the capital is held. Therefore, the bank had to include the subsidiary companies in its fixed assets and revalue on the basis of their net asset worth as shown by their published audited balance sheets. The possible consequence of the increase in fixed assets was that the value of fixed assets might be depreciated and deducted from profit. At the same time it may decrease the capital to assets ratio.
In 1977, the year in which the announcement of the acquisition of MMBI was released, the bank had disclosed more information than in previous years, and the number of notes on accounts increased to five pages.
Chapter 5 Accounting in HSBC 1967 - 1979 192
The annual report in 1978 voluntarily provided 10 years’ financial highlights, showing the progress of the Group over the decade, as well as the usual features of the bank. The Chairman, Sandberg, commented in the Chairman’s report that readers of the annual report would find these of interest. All groups provided in the annual report showed a steady growth of profit, and a big jump of almost 20% of profit from 1977 to 1978. The bank also emphasized that they had maintained a high degree of liquidity and the advance to deposits ratio in 1978 stood at 49.76%.
The deposit also resulted in a compound annual growth rate of 18.76%, which indicated that the bank was welcome and trusted by the general public who deposited and invested in it.
5.3.2 Inner reserves issues (1967-1979)
Because of the acquisition of MMBI, the US regulatory authorities expressed their concern about the use of the inner reserves of HSBC. Banks in Hong Kong were allowed to keep secret reserves accounts under the Companies Ordinance Schedule
10, which exempted a bank from observing many of the Companies’ Ordinance requirements for making and presenting accounts (Roebuck, 1994). Banks could therefore understate or overstate their profits and losses. The genuine financial figures were only disclosed to the directors of a bank, its external auditors and the authorities, and not to the public, or even the shareholders. The amount of money not disclosed could be transferred to a secret reserves account. The Board of
Directors of the bank could transfer money back to the profit and loss accounts when it suffered losses or when the profits of the year were disappointing. Unexpected losses on loans or large capital expenditures were two items that were usually covered from this account (Roebuck, 1994, 304).
Chapter 5 Accounting in HSBC 1967 - 1979 193
HSBC’s true profits were never disclosed. The bank retained its general practice of non-disclosure of true profits and its retention of inner reserves. According to the
Hongkong and Shanghai Bank Ordinance Regulation 157, ‘No shareholder shall be entitled to require discovery of or any information respecting any detail of the bank’s trading or banking business…if in the opinion of the board it is inexpedient in the general interests of the shareholders to give the information required’. The published profits in the annual reports were earnings after transfers to inner reserves.
Inner reserves were the consequences of transfers for specific contingencies, of usual or extraordinary profits, and of some Board-approved portion of normal annual profits. However, the existence of inner reserves had affected the judgement of prudential ratios, for example, the capital to assets ratio, which was low throughout (or, alternatively, the bank operated with a high leverage) (King, 1983,
723). The bank also argued that they operated in areas of exceptional risk without access to assistance from the government, and required a cushion to absorb unexpected losses or gains which might arise from circumstances beyond their control. As a result, the published profits have always shown an increase except for
1967 during the Red Guard period. If HSBC were reporting more volatile earnings, and also disclosing significant write-offs, then its legitimacy would be threatened.
Therefore it used inner reserves as an accounting device to allow it to report a steady upward trend of profits, expect in the one year, 1967, when external disturbances were so obvious that HSBC had a legitimate “excuse” for reporting lower profits.
Although the bank could keep the inner reserve account secret, they had to assure the government that they would not draw down reserves to pay dividends. The bank achieved this by adjusting the profit with the inner reserves account. The Board of
Chapter 5 Accounting in HSBC 1967 - 1979 194
Directors had the ability to even out changes in profitability by adjusting the annual allocation to inner reserves before declaring profits.
In 1973, there was a trend towards disclosure of full profits and the incorporation of inner reserves into published reserves, when the British clearing banks made public their inner reserves. The public started to take an interest in the matter of disclosure of the inner reserves account. The planned acquisition of MMBI was also raised by the United States regulatory authorities as an issue which required the bank’s reporting of the inner reserve. However, HSBC refused to do so. Sayer, the
Chairman, acknowledged this issue in the Annual General Meeting and concluded that disclosure did not appear appropriate. He also expressed his view in the
Chairman’s Statement that the “[a]ccounting techniques which may be appropriate or are judged to be appropriate in economically sophisticated countries are not necessarily suitable [in Hong Kong]” (The Hongkong and Shanghai Banking
Corporation, 1974, 4). He stressed that while disclosure might be useful to determine whether shareholders had been receiving appropriate returns, the system of inner reserves protected depositors who could be assured of additional protection beyond that declared in the balance sheet. He explained that this was comparable with the ‘additional protection’ depositors received in other jurisdictions from statutory bodies, for example, the Federal Deposit Insurance Corporation, protection which was not available in Hong Kong. Therefore, the board decided not to follow the trend of disclosure. The record of sustained growth of profit after adjustments to inner reserves and very high market rating of shares is an indication of the confidence which its depositors and shareholders placed in its accounting methods and policies. The Chairman also invited comments from shareholders about his
Chapter 5 Accounting in HSBC 1967 - 1979 195 decision on disclosure issues and there were no records of any complaint from shareholders (King, 1991).
Moreover, Sayer also referred to the volatility of the bank’s business and the impact on shareholders and depositors. He explained that as long as HSBC had major responsibilities to the banking system and the people in Hong Kong regarded the bank as a potential lender of last resort, the bank needed reserves on which it could call without endangering the public’s confidence in the bank and the entire banking system in HK during sensitive times. HSBC did not enjoy potential support from the Exchange Fund; however, the Exchange Fund played an enhanced role in supporting the integrity of the banking system (The Hongkong and Shanghai
Banking Corporation, 1974).
5.3.3 Revaluation of property and investments in subsidiaries
Besides the inner reserves issue, the bank also had major changes with respect to handling of property and of investment in subsidiary accounts. The Companies Act permitted companies to make periodic revaluations of fixed assets in the UK (Lin and Peasnell, 2000). Directors were allowed to choose to revalue fixed assets
(mostly real estate) and there was no regulation on how often they could revalue them. The regulation was tightened by the 1967 Act which required all the revaluations detailed to be disclosed in the financial statements. Any substantial differences between the market and book value also had to be disclosed in the directors’ report. Since HSBC was regulated by the Companies Act, the bank could choose to record the property at historical or current cost. A total HK$38 million was transferred from ‘Premises’ between 1962 and 1971 to write down the value of
Chapter 5 Accounting in HSBC 1967 - 1979 196
HSBC’s property. All fixed assets were depreciated at a fixed rate. However, this practice ceased in 1972. Property was revalued at market price, with a consequent impact of $200 million on the balance sheet which was not in the published shareholders’ funds (King, 1991). The whole amount was transferred to inner reserves. The reason for the change was the growth of the inflation rate. Historical cost therefore could not reflect the true value of the bank.
In 1971 the bank’s investments in major subsidiaries were revalued and it changed its accounting practices for the revaluations, which reflected a mimetic force. HSBC adopted general acceptable accounting practices in the UK in order to present the
“true” value of the bank. The first Statement of Standard Accounting Practice in the
UK, SSAP1, on associated companies, required this accounting treatment. This was due to the problem of the capital to assets ratio which was at a low of 2.7% in 1969
(The Hongkong and Shanghai Banking Corporation, 1970). Investments in subsidiaries had been shown at historical cost less the amount written off in the past.
But from 1971 onwards, they were shown at the bank’s proportionate share in their published net worth. The $180 million increase as a result of the revlaution was, exceptionally, transferred directly to the bank’s published reserves (The Hongkong and Shanghai Banking Corporation, 1973).
The bank considered the rights issue for additional capital; however, Sayer was concerned that the call would not be well received by Chinese shareholders. The
Hong Kong Chinese shareholders’ perception of the bank was that it had unlimited inner reserves. Requests for extra capital would be perceived by local Hong Kong
Chinese as a weakness and financial instability (King, 1991). HSBC therefore chose
Chapter 5 Accounting in HSBC 1967 - 1979 197 to retain the inner reserves while presenting a balance sheet in which ratios could be explained and justified by the figures actually revealed. In order to project a healthy and sound financial image to the public, the bank revalued its property at market value, which was in line with the practice other banking companies adopted, instead of issuing more shares.
In 1972 trade grew rapidly, especially in the clothing and textiles industries. Bank loans to individuals and financial institutions were doubled and loans to stock brokers were tripled. The Chairman emphasized that the Board of Directors had consulted with the bank’s auditors to revalue the properties’ amounts to HK$200 million. They were considered to be well below their current market values, but the properties were designed and mainly used for banking purposes and for accommodating staff and not for profit. The bank also considered that the figure in the balance sheet should bear a closer relationship to the market value. This was also recorded in the notes of account.
Again in 1976, the resulting changes which totalled $180 million, was due to using the net asset value method of showing investment in subsidiaries which was then transferred to inner reserves. These types of revaluations then became matters for regular notes in the annual report.
5.3.4 Audit Report 1967-1979:
Mimetic force on the annual report could further be seen from the bank’s audit reports. During 1951, many accounting and reporting changes took place in the published financial statements of HSBC. In 1951, comparative figures for the
Chapter 5 Accounting in HSBC 1967 - 1979 198 previous year were produced for the first time. From 1955 onwards, separate financial statements were disclosed for the main subsidiary companies. It was not until 1959 that the bank introduced the practice of producing consolidated financial statements, which was long after a similar change in other countries. In the same year, a vertical profit statement appeared and provided two audit opinions – a ‘true and correct’ one for the holding company statements, and a ‘true and fair’ one for the consolidated statements. It would be confusing for shareholders to grasp the difference between ‘correctness’ and ‘fairness’ (Lee, 1983).
In 1967, a ‘true and fair’ opinion was given to the holding company statements, and the consolidated statements were said to comply with the provisions of the
Companies Act. This was the coercive force that HSBC faced during that time.
From 1971 onwards, subsidiary company investments were revalued on the basis of their net asset values, thus continuously updating their consolidated reserves for reporting purposes. Inner reserves were not and are not disclosed separately.
Instead, they form part of the general liability heading, including deposit and current accounts and provisions. Later in 1975, the financial statement format changed in order to meet the auditing requirements of the Hong Kong Companies Ordinance and to provide further information as agreed with the London Stock Exchange. For example, the ‘true and fair’ opinion was given to cover all published financial statements. In relation to subsidiary companies, their reserves were included with holding company reserves (instead of being placed in undisclosed inner reserves) for the first time in 1976.
Chapter 5 Accounting in HSBC 1967 - 1979 199
In the 1976 annual report, the auditors pointed out that the property portfolio was revalued below cost. Therefore, the bank wrote up property to a more realistic figure and adopted a very conservative view. The published financial statements of
HSBC remain a relatively stark listing of assets and liabilities, supported by considerably more explanation and analysis of detail, which was in line with generally accepted banking practice. They continue to be subject to inner reserve movements of an undisclosed nature and are relatively typical of all banks’ financial statements.
5.3.5 Other disclosure issues
In 1973, the bank was required to list major loans to directors because of the impact of United Kingdom legislation on the bank. The bank is also bound by the London
Stock Exchange’s requirements. Although the disclosure regulations were opposed and objected to by the Board, the bank had to conform with the rules. The Board of
Directors argued that the provision was not necessary because the chief executives were fully in charge of management of the bank’s operation and loans were not referred to the Board (King, 1991). However, the bank was not granted special permission towards its disclosure of loans to directors.
The bank argued that the board functioned at the policy level and management is at the operation level. With the issue of policy, they were ignoring the power influences of the board. The Board of Directors argued the point of sound corporate governance practice. However, the non disclosure of loans would not be accepted in the British system, in which it was seen as a form of corruption because of their recognition of perceived as much as actual influence. But in the Hong Kong
Chapter 5 Accounting in HSBC 1967 - 1979 200
Chinese system, there is a different cultural interpretation because they show a lot of respect for position and their elders and this is not interpreted in the same way as corrupt. It is the opposite of corrupt. It would be unacceptable for one not to accept it. This shows the cultural differences between the British and Chinese systems.
Institutional theory helps us to follow what the institution is doing but does not give us the lens to explain these cultural differences. On the other hand, Laughlin’s middle range thinking gives us the lens to look at the problem from a different perspective – the taken-for-granted assumption at the institutional level with the
British and at the cultural level with the Chinese.
Moreover, the bank included a 10-year financial summary and highlight in the 1978, and a 12-year financial summary and highlights in the 1979, annual reports. HSBC used its annual report to communicate financial results to its investors, lenders and also the public at large. Annual reports were no longer accountants’ particular area of interest and there was an increasing importance for the bank to present a good corporate image through them. However, annual reports are usually written at a reading level beyond the educational skills of the audience (Courtis, 1995).
Therefore, there was a tendency for the bank to present its financial data with chart graphics as a way of communicating information to investors and others. This can be referred to as a mimetic force on the bank to present the chart graphics and financial summary voluntarily. Using charts and graphs may focus a reader’s interest, highlight trends and break down the language barrier (Courtis, 1997). In order to maintain its legitimacy and for long-term survival, HSBC included a number of charts in its annual report in 1978 and 1979. These included earnings per share, dividend per share, profit growth, shareholders’ funds, total assets and
Chapter 5 Accounting in HSBC 1967 - 1979 201 advance and deposit growth. Each of this showed an impressive growth of at least
20% from 1968 onwards.
5. 4 Capital requirement (Capital/asset ratio) 1967-1979
The capital to asset ratio measures the capital risk of a decline in asset values which adversely impacts on the bank’s equity capital position (Hogan et al., 2004). A higher capital to asset ratio will provide a better position for the bank to absorb a greater decline in asset values than would a lower ratio. The capital to assets ratio declined in 1967, due to the disturbances discussed above (refer to Figure 5-1
Summary of disturbances), such as the acquisition of Hang Seng Bank, the devaluation of sterling, and the acquisition of MMIB. This indicated that the bank had a high capital risk with a low percentage of the assets covered by equity capital.
Earnings of the bank had difficulty keeping pace with the capital requirements. The chairman aired the possibility of the need for a rights issue. This was finally agreed to by shareholders in 1980. The bank had a high leverage ratio between 4.5% and
5.9% (King, 1991). However, because of the existence of inner reserves and the absence of gearing in the capital structure, the bank could tolerate the low overall group capital to assets ratios.
In 1977, HSBC had listing in both London and Hong Kong. HSBC moved the beneficial ownership of the bank’s share from London to Hong Kong and about 70% of the capital was held in Hong Kong. It had closed the sub London register three and a half years previously and there was a widening divergence in listing. After the move of ownership to Hong Kong, the bank issued a 10-year financial highlight and
10-year financial summary in the 1978 annual report, which showed the progress of
Chapter 5 Accounting in HSBC 1967 - 1979 202 the group over the previous decade. The Hong Kong government allowed international banks of substance to open in Hong Kong, which increased competition. This may be the reason why the bank had to present the 10-year financial highlights, and used accounting as a tool to project a sound and competitive image in response to institutional pressure. The cover of the 1978 annual report also used pictures from all over the world showing different traditional costumes to symbolize globalisation. In times of uncertainty with increased competition, HSBC had to maintain its legitimacy by projecting itself as a multinational organization.
5. 5 Role of de facto central bank and accounting procedure for the
acquisition of Marine Midland Bank (MMBI)
The role of HSBC as the de facto central bank can be seen from events in 1977. The bank intervened in the local market against speculators due to its self-interest in the health of HK’s economy (South China Morning Post, 1977). The bank stabilized the exchange rate. It had the reputation of being the ogre of the exchange market. Mr.
John Gray, foreign exchange manager, commented that “what is good for Hongkong is usually good for Hongkong Bank” (South China Morning Post, 1977, 5).
The question of a central monetary authority for Hong Kong had been raised by the
Commissioner of Banking in 1978. He suggested that the Government of Hong
Kong should establish a central banking-type institution. The question was raised because of HSBC’s planned acquisition of a major United States bank, Marine
Midland Banks Incorporation (MMBI), which might curtail its money management role in Hong Kong (Hong Kong Standard, 1978). If the bank successfully acquired
Chapter 5 Accounting in HSBC 1967 - 1979 203 the American bank, it would be bound by international banking and regulatory standards. The government was also afraid that the bank would relocate its headquarters away from Hong Kong.
Moreover, two problems had been brought up by the acquisition, accounting principles and disclosures. The first hurdle for the acquisition, set by the Securities and Exchange Commission (SEC) of America, was that they requested the bank to prepare the accounts in a form which was consistent with GAAP, the American
‘Generally Accepted Accounting Principles’, because they were not currently being prepared in that way. At the beginning, the American regulators were satisfied with the audited accounts plus the explanations of accounting procedures by the bank.
They had also accepted non-GAAP accounts from foreign financial firms before
(King, 1991). However, due to the fact that a foreign bank, HSBC, declared its intention to own a major US commercial bank, they tried to set a hurdle to stop the acquisition. The second hurdle was the disclosure of the bank’s inner reserve. SEC claimed that US banks fully disclose their position.
The financial solution was that the bank accounts had to be presented as published with explanations relative to the differences between the bank’s practices and
GAAP. The bank did not have to disclose its inner reserve. It was Hong Kong’s government policy that banks should have inner reserves and not be required to make full disclosure. The Financial Secretary of Hong Kong, Sir Philip Haddon-
Cave, at that time sent a letter to the SEC and explained the situation. It also demonstrated the close relationship between the bank and the Hong Kong
Government.
Chapter 5 Accounting in HSBC 1967 - 1979 204
The bank paid the initial cost of acquiring Marine Midland Banks through its own
US dollar liquid assets. The liquidity ratio was unusually high at 56% in 1977. The
Chairman, Sandberg, reassured the shareholders at the Annual Meeting, and again in the annual report of 1978, that the bank had no need to consider a rights issue to raise funds for the acquisition. However, the cost to acquire MMBI was met by converting to equity a US$100million 7¾ subordinated note, being purchased by a wholly owned subsidiary, which did not show in the bank’s financial statement in
1978. It was included under ‘advances to customers and other accounts’ in the
Consolidated Balance Sheet. This was disclosed in Note 3 of the annual report. The liquidity ratio of the bank in 1979 continued to be high with 60.7% and the capital/assets ratio stayed above 3%. This disclosure approach could increase its liquidity ratio since the total amount of current assets increased because the cost of acquisition was included in the “advances to customers” account.
Figure 5-4 Capital/Assets Ratio 1967-1979
Capital/Assets Ratio 1967 - 1979
6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 Year
In 1979, the bank also provided a liaison office in Guangzhou for the entire duration of both the Spring and Autumn Fairs to provide service for traders visiting the
Guangzhou Commodities Fair. The bank also redeveloped its headquarters at 1
Queen’s Road in Central, Hong Kong. As the chairman put it, this showed “long-
Chapter 5 Accounting in HSBC 1967 - 1979 205 term commitment to Hong Kong” (The Hongkong and Shanghai Banking
Corporation, 1980, 3). The bank believed that the redevelopment would produce a building of which the Bank and Hong Kong as a whole could be proud of. The bank also appointed Foster Associates of London as the architects.
Following the 1967 devaluation of sterling, various schemes had been developed for guaranteeing the value of Hong Kong’s sterling reserves, culminating in the Basel
Agreement. Sterling was floated in 1972. With the end of the Bretton Woods post- war monetary settlement55 in 1974, the Hong Kong dollar itself was floated. It was the sign of the break-up of the Sterling Area and also a basis for the development of
Hong Kong as a major financial centre. HSBC set aside an exchange contingencies fund within its inner reserves. The bank was once again an ‘exchange bank’.
To sum up
This chapter discussed HSBC’s financial reporting changes between 1967 and 1979.
HSBC had struggled between the institutional forces and disturbances which emanated from both external pressure (the devaluation of Sterling and the acquisition of Hang Seng Bank) and internal pressure (the acquisition of MMBI).
These institutional forces formed coercive and mimetic influences on HSBC’s financial reporting during this period. Due to a number of bank runs in 1967 and the devaluation of sterling, the Banking Ordinance was amended in 1967 to tighten up the financial reporting regulations. HSBC successfully acquired the largest local
55 Under the Bretton Woods system, each participating country established a part value in relation to the US dollar which was pegged to gold at $35 per ounce. The US dollar was the only currency that was fully convertible to gold. Other currencies were not directly convertible to gold Eun, C. S. & Resnick, B. G. 2007. International Financial Management. United States, McGraw-Hill..
Chapter 5 Accounting in HSBC 1967 - 1979 206
Chinese bank, Hang Seng Bank, during the bank run and earned a high degree of acceptance and confidence from the public in Hong Kong. HSBC had to comply with the accounting standards in response to the coercive force from the Banking
Ordinance. For example, the bank had to follow the Company Act for the revaluation of property and investments account, and had to monitor its capital to asset ratio.
The acquisition of MMBI also affected the bank in its reporting requirement to disclose its inner reserve, audit reports, and its capital account. Because of the acquisition, HSBC listed in both London and Hong Kong. Therefore HSBC had to conform with both the London Stock Exchange listing requirements and the
Securities and Exchange Commission of America. HSBC started to emerge as “one bank, two cultural identities” following the acquisition of MMBI in late 1979.
HSBC had to project as a sound financial institution in order to survive and maintain its legitimacy both in Hong Kong and internationally.
Chapter 6 Accounting in HSBC 1980 - 1996 207
CHAPTER 6 ACCOUNTING IN HSBC 1980-1996
This chapter discusses major events between 1980 and 1996 and their effects on the annual financial reports of HSBC. This period is significant for HSBC because this was the start of the negotiation for the handover of Hong Kong to China, which would affect the status of HSBC as well as financial reporting in Hong Kong.
HSBC had strategically established itself with two systems in response to the external disturbances.
Section 6. 1 describes disturbances during the 1980s, such as the banking crisis; the restructure of HSBC after the acquisition of Marine Midland Bank Incorporation
(MMBI); the 1997 “Confidence crisis”; the stock market crash in 1987; the new accounting arrangements in 1988; and the restructuring of HSBC Holding in 1990.
It is followed by the resulting accounting issues in section 6. 2. These accounting issues include the provision for bad and doubtful debts, the capital/asset problem, taxation issues, disclosure of an inner reserve and the surrounding political issues.
The annual reports of HSBC changed over this turbulent and uncertain era of the 80s and 90s. This uncertainty drove HSBC towards isomorphism in order to achieve long-term sustainability in Hong Kong. They attempted to manage and control it through organizational changes, such as taxation responses and disclosures in the annual reports. Section 6.3 explains how HSBC emphasized imaging of their accountability in their annual reports between 1994 and 1996, three years before the change of sovereignty.
Chapter 6 Accounting in HSBC 1980 - 1996 208
6. 1 Disturbances during the 1980s Disturbances 1980 Restructure of HSBC 1982-1986 Banking crisis 1984 1997 issue 1987 Stock market crash 1988 New accounting arrangements 1990 Move to London
Banking Crisis
1980 1982 1984 1986 1987 1988 1990 Restructure “1997 issue” Stock New Move of HSBC market accounting To crash arrangements London
6.1.1 Banking crisis
In response to the oversupply of banks and the crisis described in the previous chapter, no further banking licences were issued in 1980. As a result, there was a rapid expansion of branch networks by banks in Hong Kong. The total number of banking offices for all banks in Hong Kong increased from 127 to 1033 (Hong Kong
Government, 1982). The registered Deposit-Taking Companies (DTC)56 also extended their penetration in the market and their offices were estimated at 500
(Hong Kong Government, 1982). There was a famous saying during that time “the
56 Deposit-taking companies are owned or associated with banks and engage in specialized activities including securities business, trade finance and consumer finance. They may take deposits of HK$100,000 or above with an original term of maturity of at least three months.
Chapter 6 Accounting in HSBC 1980 - 1996 209 number of bank branches outnumber the number of grocery shops” (Asia Television
Ltd., 2007).
A major banking crisis broke out between 1982 and 1986. It started in September
1982 when a run on the Hang Lung Bank began due to its high risk exposure. This bank was rescued by several leading banks, including HSBC. Also, several DTCs had large exposure in the property market, and encountered insolvency problems and later failed to repay their bank loans. There were rumours about the soundness of the Hang Lung Bank again in 1983 and the Hong Kong dollar dropped significantly. The Hong Kong Government restored public confidence by announcing that a currency stabilization plan was under consideration. The Hong
Kong Government took over the Hang Lung Bank and the Overseas Trust Bank, which was one of the largest locally incorporated banks. Besides the Hang Lung
Bank, several banks57 had been liquidated and acquired by the major banks in Hong
Kong. HSBC acquired the Wing On Bank during the banking crisis. Only a handful of purely Chinese banks remained in Hong Kong after this crisis. Jao (1988) suggested the main reasons for this crisis was the imprudent management committed by directors or senior executives of banks and DTCs, a rapid fall in property prices and in the Hong Kong dollar exchange rate, and excessively loose banking regulations in Hong Kong which were inappropriate to handle an expanding banking system.
57 Ka Wah Bank was acquired by the China-owned China International Trust and Investment Corporation, Wing On Bank was acquired by HSBC, the Union Bank was acquired by the Modern Concepts Ltd, and the Hon Nin Bank was acquired by the First Pacific Group.
Chapter 6 Accounting in HSBC 1980 - 1996 210
Therefore, the government had to tighten its regulation of the banking sector in
1986. A new Banking Ordinance was enacted and marked a monumental change in
Hong Kong’s banking regulations. This Ordinance governed both banks and DTCs, and the commissioner of banking supervised both types of institution, and a minimum capital ratio requirement was instituted which will be discussed in section
6.2.3
6.1.2 The restructure of HSBC
As mentioned in Chapter five, HSBC began to acquire the Marine Midland Bank
Incorporation (MMBI) in 1977 and brought up the question of financial reporting and disclosure. The acquisition was finally completed in 1980. From the bank’s point of view, the takeover of MMBI in New York in 1980 was regarded as spreading its wings away from Hong Kong and against a possible political
“judgement” day, the 1997 issue (Sillitoe, 1980). Following the acquisition of
MMBI, the bank was restructured under a Scheme of Arrangement. Hongkong
Bank became the principal subsidiary of HSBC Holdings PLC. Although HSBC was not a public sector body, it was a de facto central bank of Hong Kong (refer to section 4.6.2) during 1980s. The general public had the perception that it was accountable to the public in Hong Kong. Therefore, some people were critical that the management of the bank was only accountable to the shareholders, and not to the public, after its restructure (Yam, 1990). Even the Treasurer of Hong Kong commented that the role of HSBC must be discussed (Yam, 1990). HSBC not only restructured their lines of authority and responsibility, but also restructured at the cultural level. There was a clash in their societal role between social responsibility
Chapter 6 Accounting in HSBC 1980 - 1996 211 and a purely capitalist attitude. Annual reports were therefore a very important tool with which HSBC could maintain its legitimacy.
After the acquisition of MMBI, the “International Survey”58 discontinued from 1981 because HSBC thought that equally authoritative sources of regional information were available more speedily. The bank claimed that the group’s activities were
“truly global rather than regional” after the acquisition of MMBI. Globalisation became the theme of the bank from 1980 onwards. The decision not to publish the
International Survey may be the result of a belief that “its perpetuation is no longer rewarding” (Oliver 1992, 571). HSBC may have found that there was no need to use its International Survey to project a global image to the public. Acquiring
MMBI had already symbolized that their operations had worldwide scope and were not just regionally focused.
Consistent with its expansion into the US market with the acquisition of MMBI,
HSBC also made use of their annual report to emphasize their idea of globalisation.
The bank’s annual reports in 1980 and 1982 were granted awards at the Mean
Library of Ideas International Annual Reports Show (King, 1991, 862). A picture of a face, half of which was a character from Chinese opera and a half the Statue of
Liberty (refer to Figure 6 – 2) to represent New York, featured as the cover of the
“Review of operations and essay” section of the annual report in 1980. The bank opened its first agency in New York in 1880 by the request of its then merchant agent, Russell and Co. It was now exactly 100 years since the bank had had a
58 International survey is a section of HSBC’s annual report which described their operations over the world.
Chapter 6 Accounting in HSBC 1980 - 1996 212 presence in New York. The annual report of 1980 featured an essay “The Pearl of the Orient with the Big Apple” which was written by Anthony Sampson. The author compared Hong Kong (pearl of the orient) and New York (Big Apple). The picture of a half pearl and a half apple forming one symbol was in the two central pages of the essay (refer to Figure 6-1). The annual reports in both 1980 and 1982 were designed by Henry Steiner59 and the photos in 1980 annual report were photographed by Ken Haas.
Figure 6-1 1HSBC Annual Report 1980 – “The Pearl of the Orient with the Big Apple”, 3
Figure 6-2 HSBC Annual Report 1980 cover
59 Henry Steiner was a local consultant and designer of the Bank’s annual reports.
Chapter 6 Accounting in HSBC 1980 - 1996 213
In 1982, the bank put the new company logo on the cover of its annual report for the first time. The bank tried to change its corporate identity. It used a new group symbol, the hexagon logo, and the descriptive single word “Hongkong Bank” (see
Figure 6-3). The bank believed that this new ‘signature’ would be valuable to them in international marketing efforts. This was the start of the mimetic forced imposed on HSBC through its corporate logo. HSBC could use its new corporate identity to maintain its legitimacy in Hong Kong. Other multinational organizations had become a set of initials, for example, KLM. By mimicking a successful multinational organization, HSBC could increase its prestige, stability, and legitimacy (Meyer and Rowan, 1977, Meyer and Scott, 1992). Another reason for
HSBC changing its corporate identity may be that its lion and unicorn (refer to 4. 3) might ruffle Chinese sensibilities after 1997.
Figure 6-3 Hongkong Bank logo in 1982
Source: King, 1991, 873
Chapter 6 Accounting in HSBC 1980 - 1996 214
In the same year, 1982, the share market crashed due to uncertainty over the fate of
Hong Kong in 1997. There was also a temporary but severe lack of confidence in the US dollar which further affected the value of the Hong Kong dollar. This then triggered the fraud and deception and liquidity problems of the local small to medium-sized banks (Jao, 1987, Mulcahy, 1984, South China Morning Post, 1984,
Tang, 1984). The stock market fell by 57% and the property prices fell by 60% within months in 1982-83 (Jao, 1987). The consequence of the erosion of borrowers’ remaining assets values was that a large portion of bank loans were unsecured. Many local small to medium-sized banks and deposit-taking companies faced huge problems of liquidity because of their heavy involvement in mortgages and real estate investment. Local banks such as the Hang Lung Bank, Sun Hung Kai
Bank, Overseas Trust Bank, Hong Kong Industrial and commercial Bank, Wing On
Bank, and Hon Nin Bank were hit by bank runs during 1982-1986 (Jao, 1987,
Mulcahy, 1984). HSBC and the Bank of China had an undisclosed commitment to the Exchange Fund60 to support almost all of the problematic banks. The Exchange
Fund gradually took over the role as the lender of last resort, which had been performed by HSBC before. HSBC was no longer willing to rescue the problem banks. The Hong Kong dollar was under strong pressure of depreciation. To prevent a breakout of a currency crisis, the government announced the pegged rate system in September 1983.
HSBC was using the annual report to project itself as a secure bank in Hong Kong after the collapse of some local Chinese banks. The bank used the pictures in the
60 The Exchange Fund was set up in 1935 by the Hong Kong Government.
Chapter 6 Accounting in HSBC 1980 - 1996 215 annual report as a reflection of reality (Preston et al., 1996). The theme of the 1982 annual report was “Security, A Modern Paradox”. The cover of the annual report featured a bronze lion “arresting lock” produced in France around 1780 (Figure 6–4) with an “s” keyhole in the lion’s month. The lion’s jaw will clamp over the miscreant’s wrist if the proper key is not used. A small picture of the original lock was printed on the second last page of annual report without that “s” keyhole.
Therefore the cover picture of the annual report was a combination of the actual lion lock and the symbol of security, the S-shaped keyhole. It is a little like a dollar sign.
The graphic designer, Henry Steiner, also commented that “security is virtually synonymous with banking”. The insets showed on the cover page the Identimat system61 which employed a combination of hand scanner and identity card to control access to restricted areas of the bank.
Figure 6-4 Cover of 1982 annual report
61 Identimat system is an ancient lock system. Any attempt to tamper with the mechanism without the proper key will trigger the lion’s jaw to clamp over the miscreant’s wrist.
Chapter 6 Accounting in HSBC 1980 - 1996 216
The photo can be seen as a symbol and a metaphor to connote a correspondence between HSBC bank and security. HSBC attempted to transmit an emphatic
“message”, and to link the image to a particular corporate attribute, safety and security (Preston et al., 1996). The annual report of 1982 also contains messages intended to address social concerns about the bank runs (see section 6.1.1). There were 16 full pages of illustrations inside the annual report of past security devices used by HSBC and insets of contemporary versions of the devices. The pictures ranged from locks compared with electronic circuitry to replace the locking devices, the bank’s first building compared with the contemporary design of their new
Treasury (Figure 6-5), money boxes compared with the electronic ETC62 machine accepting deposits, ironwork of a decorative key-plate compared with a laser beam photographed in a laboratory, security patterns on banknotes compared with patterns visible only under ultraviolet light, a gateway’s iron grille compared with a surveillance camera monitoring the entrance of the bank’s treasury, and symbols of security appearing on firemarks compared with the bank’s hexagon symbol (Figure
6-6), and various traditional keys compared with the ETC card. HSBC used all of the ‘security’-related images and artefacts to present their corporate image in order to maintain and achieve legitimacy.
62 Electronic Teller Card.
Chapter 6 Accounting in HSBC 1980 - 1996 217
Figure 6-5 First building of HSBC and new Treasure
Source: HSBC annual report, 1982, 17.
Figure 6-6 Symbols of security on firemarks and HSBC’s hexagon symbol.
Source: HSBC Annual Report, 1982, 34.
Chapter 6 Accounting in HSBC 1980 - 1996 218
There were many ways to see an annual report. Pictures and illustrations could
“decode[d] deeply embedded social significances brought to the image by the photographer/designer as well as the viewing subject” (Preston et al., 1996, 113).
HSBC attempted to portray the corporate messages of technology, progress and security in the realistic and metaphoric components of its images. The lion lock symbolized the bank itself. The bank has always been referred to by the public as the lion bank. It wanted to project the image of safety and soundness. The keyhole
S symbolized security and protection. The technology shown in the inset also projected the image of high technology and the progress of the bank into the future.
Apart from the images and pictures, HSBC also included an essay in the 1982 annual report describing the illustrations and pictures of the report. The word
‘confidence’ appeared most frequently throughout the essay (The Hongkong and
Shanghai Banking Corporation, 1983). This essay ended with the comment “the holder of the key is himself the key”. The author used the “key” to represent the bank as being able to provide safety and security to its shareholders as well as the public.
During the time of turbulence, such as the banking crises which were triggered by the bursting of a property bubble and concerns about Hong Kong’s future, an image of security was very important so that HSBC could stabilize public confidence in the bank. HSBC inserted 15 pages63 of images and pictures which symbolize security in their 1992 annual report in response to this disturbance. HSBC used their annual reports to construct corporate reality. The number of notes on accounts increased by
100% from 1991 to 1996 (refer to Figure 6-7).
63 The 1992 Annual Report has a total of 52 pages.
Chapter 6 Accounting in HSBC 1980 - 1996 219
Figure 6-7 Total number of pages in annual report 1980-1996
Total number of pages in annual report 1980 - 1996
100% 90% 80% 70% 60% 50% 40% Percentage 30% 20% 10% 0%
8 8 9 1980 1981 1982 1983 1984 1985 1986 1987 1 1989 1990 1991 1992 1993 1994 1995 1996 Balance sheet and Profit and loss account Year Notes on account Other information
In 1982 more financial information was included in the annual report than the legal requirement. This is reflected in Figure 6-7. HSBC added pie charts for the
“Current, Deposit and other Accounts” (excluding inner reserves) and “Total
Assets” of the Group. This showed clearly the distribution of its accounts. For
“Current, Deposit and other Accounts”, around 50% belonged to the deposit accounts, then savings accounts and deposits from banks account. Government accounts comprised only 5%. For “Total Assets”, advances acquired almost half of the bank’s assets, followed by cash and short-term funds and deposits with terms of up to 12 months. The bank’s advances were mainly to commercial, industrial and international trade, and property. The bank also included the number of shareholders. Although the number of shareholders was not classified as financial data, the bank included it as a reference for readers of the annual report.
In line with the theme of globalisation of the bank, the bank added the geographic distribution of group assets in 1984. HSBC used voluntary disclosure of its
Chapter 6 Accounting in HSBC 1980 - 1996 220 operations around the world to project an image of itself to the public as a “world local bank”, seeking to maintain its legitimacy. The bank divided its operations into
Europe, the Middle East, the Americas, and the Asia Pacific regions. In 1987, the bank also included the number of offices in its annual report and its distribution in different subsidiaries. The bank also added the group capital resources. This showed that shareholders’ funds had increased significantly in 1987 and the minority interest was down as a result of the purchase of the balance of the equity in
MMBI. The bank also included its operating costs to total income by percentage. It also included a group income analysis of its net interest income, non-funds income and other income. This showed that net interest income incorporated more than half of the bank’s income. However, these two analyses did not disclose the actual amount of the operating cost and the total amount of income.
In 1982 HSBC was the first to formalize a 20-year mortgage scheme for residential properties anywhere in Hong Kong. The bank emphasized “anywhere” in Hong
Kong because the leaseholds of the New Territories would expire in 1997. There might be a possible legal problem for 20-year mortgage loans on leaseholds that expired in 1997. However, HSBC’s local General Manager during that time, Mr.
Peter Wrangham, emphasized that they did not need additional collateral for those properties. He explained that the bank relied on the personal commitment of the individual borrower to meet mortgage repayments beyond 1997 (Yau, 1982). This scheme represented the bank’s confidence in the future of Hong Kong because the
20-year term matured beyond 1997 and implied that the bank would continue to stay in Hong Kong after 1997. As Yau (1982) commented, HSBC used this scheme to give a big boost to public confidence in the bank after 1997. HSBC used this
Chapter 6 Accounting in HSBC 1980 - 1996 221 scheme to legitimize itself in Hong Kong. It is interesting to see that although
HSBC is a “British” bank, the General Manager explained that its credit culture was based on trust, which was a Chinese tradition. Chinese cultural influence on the bank can be seen through this new scheme.
Bank note of HSBC
As discussed in section 4. 7, early British settlers in Hong Kong had an interest in feng shui. Since 1935 most of HSBC’s global offices have a pair of lions outside guarding the building (see Figure 6-8). Local films and television series set in Hong
Kong, and especially the media, refer to the bank as the “lion bank”. The lion is also referred to as a symbol of the British Empire. As shown in Figure 6-9, a local
Chinese newspaper editor used a lion to symbolize the British Empire fighting for
Hong Kong against the Chinese Government, which was symbolized by a dragon.
In Asian culture, lions are feng shui symbols of good fortune.
Chapter 6 Accounting in HSBC 1980 - 1996 222
Figure 6-8 The bronze lion statue outside the HSBC building.
Figure 6-9 Drawing in South China Morning Post 1984
Source: Choi, South China Morning Post, 1984, 26
This lion is still one of the symbols the bank has kept throughout the years. This lion symbol, with the mix of Chinese and British culture, is embedded in the culture of HSBC. As mentioned in section 4. 3, the bank’s crest has been printed on
Chapter 6 Accounting in HSBC 1980 - 1996 223 banknotes issued by the bank since 1865. It is suspected that HSBC, wishing to avoid ruffling Chinese sensibilities about the 1997 handover issue, changed its corporate image to the hexagon logo in 1982. However, it kept the lion as a major symbol on the bank notes in 1990 (refer to Figure 6-12).
Figure 6-10 Hongkong and Shanghai Banking Corporation one dollar note in1872.
Chapter 6 Accounting in HSBC 1980 - 1996 224
Figure 6-11 Hongkong and Shanghai Banking Corporation ten dollar bank note in 1982.
Figure 6-12 Hongkong Bank ten dollar banknote 1990
Chapter 6 Accounting in HSBC 1980 - 1996 225
In 1994, three years before the handover to China, HSBC changed the design of its banknote. As seen in Figure 6-13, the bank’s crest with lion and unicorn was replaced by a large figure of a lion’s head. The external environmental exerted pressure on HSBC to adjust its practices in harmony with externally dictated conditions. Although the bank might have unwillingly adopted the new culture, they wanted to be seen to be doing it willingly (Laughlin, 1991). The organisation is assumed to passively try to get back its original position in its culture if possible
(Greenwood and Hinings, 1993). Therefore, HSBC discarded the lion and unicorn crest which symbolized British power and replaced it with a generally acceptable symbol, the lion. This lion is still the major symbol of the bank in 2008 (refer to
Figure 6-14).
Figure 6-13 HSBC twenty dollar banknote 1994
Chapter 6 Accounting in HSBC 1980 - 1996 226
Figure 6-14 HSBC twenty dollar banknote 2003
6.1.3 Hong Kong “1997 issue”
Later in 1983, when uncertainty about the political future after 1997 led to a significant capital outflow from Hong Kong generally, Hong Kong confronted a serious financial crisis. The strong US dollar and speculation created a heavy downward pressure on the exchange value of the Hong Kong dollar. The Hong
Kong dollar depreciated from 6.10 against the US dollar at the end of 1982 to 7.595 in 1983. It then slumped down to 9.6 on 24th September 1983. The Hong Kong
Government had to change the exchange rate system from a freely floating rate to a linked exchange rate system (South China Morning Post, 1983).
The Hong Kong dollar depreciated 8% on 24th September 1993. Several local small to medium banks were hit by bank runs because of high rising interest rates and the
Chapter 6 Accounting in HSBC 1980 - 1996 227 depreciation of the Hong Kong dollar. An emergency meeting in the government’s
Monetary Affairs Department was held on Sunday64. The Secretary for Monetary
Affairs, the Banking Commissioner, two government economists, one representative of HSBC and one from the Standard Chartered Bank attended the meeting. This demonstrates the dominance of the British banks in Hong Kong (Cottrell, 1993).
Later on 14th October, after a meeting by the group including the colonial governor, the Financial Secretary, and Sandbery (the then chairman of HSBC), the Hong Kong dollar was pegged to the US dollar at a rate of 1 to 7.8. This further demonstrated the high status of the bank in the banking and financial policy-making process in the colony. The motivation of HSBC’s support for the pegging to the US dollar may have been a long-term strategy. HSBC was successfully selected as the official
Settlement Institution for the US dollar clearing system in Hong Kong during 2000 by the selection panel of HKMA (Hong Kong Monetary Authority, 2000a). The bank’s involvement in the decision to peg the Hong Kong dollar to the US dollar increased its legitimacy, helping it to become the clearing bank of the US dollar.
The issue of 1997 became an ad hoc topic for its annual report. The content of the director’s report is normally dictated by the Corporations law (Anderson and
Epstein, 1996, 61). It contains a review of the operations and the results of the operations during the financial period and any significant change in the state of affairs of the economic entity. Anderson and Epstein (1996) concluded that shareholders seek out information on the future prospects of the company which may be found in the chairman’s statement and director’s report. The Chairman even commented on this issue in the 1983 annual report, which is one year before
64 Sunday is not a working day in Hong Kong.
Chapter 6 Accounting in HSBC 1980 - 1996 228 negotiations between the British and Chinese governments over the future of Hong
Kong. “Confidence has subsequently been boosted by progress in the discussions between the UK and China on the constitutional future of Hong Kong. This sentiment rests on the general expectation that the final form of the agreement will embody assured recognition of Hong Kong’s distinctive needs” (The Hongkong and
Shanghai Banking Corporation, 1984, 4). The Chairman also commented that
“Hong Kong’s people have and must retain the freedom of spirit to be innovative, rather than derivative; to be at liberty to seek fulfilment of all aspects of their lives through priorities of their own making and not according to priorities imposed by authority” (The Hongkong and Shanghai Banking Corporation, 1984, 4).
The cover of the bank’s 1984 annual report was a portrait of a seven-year-old Asian girl, Fong Sze Man, who would celebrate her 21st birthday in 1997, as shown in
Figure 6-15. The bank thought that this girl represented Hong Kong’s future generation, growing up with high technology in the electronic age. This cover used a picture of the traditional lion dance mask computer processed into coloured pixels as the frame of the cover portrait. HSBC used the traditional lion mask to represent
China, but it blurred the picture by using the computer technique. From an Asian perceptive, the reader can easily tell that the background is a modified image of a
Chinese dance lion. The use of the Chinese lion is an interesting combination of the lion symbol with a Chinese cultural context. It is also suspected that the bank used the dance lion to represent the backing of China, but in a subtle way, and at same time would present it in a subtle way. Therefore HSBC explained the pictures at the back of the annual report of 1984.
Chapter 6 Accounting in HSBC 1980 - 1996 229
Figure 6-15 1984 Annual report cover
Annual reports represent a social construct. “The truth lies [instead] in the colour pictures that now form an integral part of the financial statements. They encapsulate the intrinsic nature of the real accounts” (Cooper et al., 1992cited in Graves et al.,
1996, 60). HSBC used the pictures on the annual report cover to construct the relationship according to the economic reality they purported to represent. It wanted to send the message to the general public that HSBC is a local bank with a close relationship or backing from the Chinese Government.
The theme of the annual report was “A New Hong Kong”. The bank had chosen this theme because the question of 1997 had been resolved by the Sino-British agreement, after a period of uncertainty. This agreement assured the continuity of
Chapter 6 Accounting in HSBC 1980 – 1996 230
Hong Kong’s economy for 50 years beyond 1997. The bank also emphasized that
‘the territory [Hong Kong] can look forward with renewed energy and optimism”
(The Hongkong and Shanghai Banking Corporation, 1985, i). It stated that the theme of the annual report “seek[s] to depict those changes as, in their different ways, they help create a new Hong Kong” (The Hongkong and Shanghai Banking
Corporation, 1985, i). It symbolized that the bank would continue to grow and celebrate the change of sovereignty. The Chairman also commented that political and economic factors affected the bank’s success and the bank viewed the Sino-
British agreement as “a great boost to business prospects” (The Hongkong and
Shanghai Banking Corporation, 1985, 2).
6.1.4 HSBC realigning itself with China in the 1980s
The bank wanted to have a closer relationship with Chinese merchants. In 1979,
HSBC sold its one-third stake in Hutchison Whampoa65 to Mr. Li Ka Shing, who led a Chinese conglomerate, actively participated in Beijing (China) affairs and had business links with China, instead of Jardine, Matheson Holdings Ltd. The then
Chairman and Vice-Chairman of HSBC, Sandberg and Boyer, made the deal with
Mr. Li and announced it to the public on the evening of 25th September 1979 at
11.30pm. It also allowed Mr. Li to extend the payment for the remaining 80% of the loan. According to some analysts, the bank hoped that the close relationship of Mr.
Li with the Chinese government would help its future once Hong Kong was handed back to China. The former chairman of the Bank also realized that British power in
65 Hutchison Whampoa was a listed company in the 1970s, domiciled in Hong Kong. It was first established in Hong Kong by a group of expatriate British merchants.
Chapter 6 Accounting in HSBC 1980 – 1996 231
Hong Kong would fall after 1997 (劉詩平, 2007, 洪一峰, 1992)66. It may have been a strategic rather than a commercial decision to deal with Mr. Li. Tension between the West and China over the “1997 issue” may have affected the bank’s decision making. Mr. Li later became a member of the Board of Directors of HSBC in 1980. He also became the Deputy Director of HSBC in 1985.
Another example of HSBC trying to move away from the British was assisting a local Chinese merchant, and also the first Chinese Director on the Board of HSBC,
Mr. Pao Yue Kong, to acquire shares in the Hong Kong and Kowloon Wharf and
Godown Company in the 1980s. In response to institutional pressures and uncertainty, an organization may choose to co-opt the source of the pressure (Oliver
1991). HSBC had faced pressure from the handover of Hong Kong. Therefore,
HSBC strategically used institutional ties to demonstrate its worthiness and acceptability to the external constituents from whom it hoped to obtain legitimacy
(Oliver 1991). Mr. Pao was a Director of the bank between 1971 and 1984. He was also the Deputy Chairman of HSBC from 1980 to 1984 (Mulcahy, 1986). By supporting Pao, HSBC demonstrated to the Chinese Government and public in Hong
Kong that they welcomed the handover of sovereignty.
Hostilities broke out between HSBC and Jardines in June 1980, launching a cash and share bid for Wharf (renamed Wharf Holdings in 1986 ). The fight was between
Landmark and Mr. Pao for a stakeholding of the company. Sandberg and Boyer granted a loan of HK$15 billion to Mr. Pao. With the help of HSBC, Mr. Pao and
66劉詩平 (Lau Xi Ping) and 馮邦彥 (Fung Bong Yin) are authors of the book. It is written in Chinese to emphasize the Chinese perspective on HSBC.
Chapter 6 Accounting in HSBC 1980 – 1996 232 his team were able to put together a successful cash tender for shares to take his holding to 49% and securing control of Wharf (Hutcheon, 1990, Mulcahy, 1986).
The World-Wide Shipping Group Fleet that Pao owns , indirectly made the bank one of the world’s biggest ship owners. It also had a 5.4% stake in Pao’s large quoted flagship, World International (Holdings). The bank held outstanding mortgages on a number of its partly owned vessels. It there was any substance to market concern over Pao’s charter position, and his depreciation policy for the future for expensive vessels, then HSBC would obviously be affected. Wood, Mackenzie, a British stockbroking firm, commented on the bank’s increasing alignment with powerful local Chinese interests such as Pao, saying that “the advantages of this policy have to be balanced with the significant financial involvement in major local companies in which directors of the bank have large stakes” (Lauriat et al., 1982, 39).
However, HSBC was criticized because they might have violated the Banking
Ordinance by lending to Mr. Pao. According to the Banking Ordinance, HSBC could not lend more than HK$25 million or more than 1% of its capital to a director on the Board and/or his or her relatives. They also did not disclose the loan to Pao in the financial report. Therefore Boyer, the then Vice-Chairman of the bank, explained to the public that the bank had not violated the law, and that lending to
Mr. Pao was purely between the bank and a client, even though Pao was the Director of the Board. The bank commented in its 1980 annual report that it “continued to practise its prudent policy of maintaining high liquidity” although there was a substantial growth in loan and advances to customers. In the writer’s opinion, this may due to the fact that the bank had the power to influence the bank association
Chapter 6 Accounting in HSBC 1980 – 1996 233 with its close relationship with the British. Therefore this incident was gradually forgotten by the public. HSBC used the bank association to legitimize it as a reliable bank.
During 1966-1969, the Shanghai branch operated at a breakeven level throughout the Cultural Revolution (King, 1991). In 1978, the bank had established a ‘China
Desk’ in the Hong Kong office, run by Barnham, who was later to become the manager in Shanghai. He was succeeded by Page, a graduate in Chinese Studies from Leeds University. In 1979, an officially unrecognized representation was established in Guangzhou. The bank gradually developed a better relationship with the Chinese Government. Representative offices in Beijing and Shenzhen (China’s newly created Special Economic Zones) were authorized and established in 1980 in response to China’s Open Door Policy. The Chinese government welcomed foreign investment in China. Therefore, HSBC was invited to supplement its Hong Kong based China-financing offices. The chairman of the bank, Sandberg, also hosted a reception in Beijing’s Great Hall of the People67. A reception in the Great Hall of the People symbolized the close relationship between HSBC and the Chinese
Government. It also symbolized the acceptance of the bank by the Chinese
Government. The bank started to become involved in financing business in China.
Board structure of HSBC
As mentioned above, HSBC did not have its first Chinese on the Board of Directors until 1971 when Mr. Pao was elected and he later became the Deputy Director of the bank in 1980. From Figure 6-16, the number of Chinese or Asians on the Board of
67 The Great Hall of the People functions as China’s parliament building. It is used for legislative and ceremonial activities by the Chinese Government.
Chapter 6 Accounting in HSBC 1980 – 1996 234
Directors increased significantly, especially after 1997. HSBC was regarded as a
British bank, partly because of its colonial status and the traditional profile of the bank’s senior management. Although Mr. Pao was a Chinese, he was also a
Commander of the British Empire (CBE). This implied that British culture was embedded in HSBC. It also indicated that HSBC embodied the metaphor of “one bank, two cultural identities”. In order to maintain its legitimacy in Hong Kong after 1997, HSBC had to project an image of local participation to the Chinese
Government, as well as the general public in Hong Kong.
Figure 6-16 Number of Board of Directors 1967-2004
Number of Board of Directors 1967 - 2004
25
20 N
u 15 m b non-Asian 10 e Asian r 5
0 1967 1971 1975 1979 1983 1987 1991 1995 1999 2003 Year
HSBC started to print pictures and profiles of all the members of the Board of
Directors in 1994. Judging by their profiles, they were closely related the Hong
Kong Government. For example, two of the board members in 1994 were members of the Executive Council, including its Chairman, J. Gray, who was also a member the Governor’s Business Council in Hong Kong.
Chapter 6 Accounting in HSBC 1980 – 1996 235
The Board of Directors was composed of members of the Executive Council, the
Governor’s Business Council in Hong Kong, the Economic Advisory Committee to the Financial Secretary in Hong Kong, the Hong Kong General Chamber of
Commerce, the Committee Chairman of the Stock Exchange of Hong Kong Limited, members of the Hong Kong Trade Development Council, and the Director of the
London Stock Exchange, and the Executive Committee of the PRC-based All China
Federation of Industry and Commerce (The Hongkong and Shanghai Banking corporation, 1985, 1986, 1987). This reflected that the bank was well connected not only with both the Hong Kong and the British Governments, but also with business in China.
A picture of Vincent Cheng, Executive director of HSBC, was printed on the page after the Chairman’s statement in 1996, one year before 1997. This was the first time HSBC had printed a picture of its Executive Director in the annual report.
HSBC used its annual report to project the image to public that the bank was not only owned by the British, it belonged to the local people in Hong Kong as well.
6.1.5 Stock market crash in 1987
In 1987, Hong Kong’s stock market crashed and the Hang Seng Index plunged by
45% in three weeks. The Hong Kong Stock Exchange was suspended for four days from 20th-23rd October. A number of brokers were not able to meet their obligations. HSBC had a 20% shareholding in the Hong Kong Futures Guarantee
Corporation. It was seriously undercapitalized in relation to the magnitude of the defaults which it might be called upon to cover (The Hongkong and Shanghai
Banking Corporation Limited, 1989). Despite this, the bank strongly emphasized
Chapter 6 Accounting in HSBC 1980 – 1996 236 that there was no significantly adverse effect on either corporate or retail loan demand in the coming year. To rescue the futures market, the bank committed a total of almost HK$700 million to the two facilities in support of the Guarantee
Corporation. The Hong Kong Government, major brokers, BOC and HSBC organized a total HK$4 billion in support of the Guarantee Corporation. Since the second facility of HK$2 billion was voluntary and not required by the government and the bank association, the bank claimed that they would therefore reduce their exposure to only HK$357 million (The Hongkong and Shanghai Banking
Corporation Limited, 1989). The Chairman explained that if the rescue had not been speedily organized, investors who had hedged their equity positions through the futures market might have found that their contracts were either worthless or closed out at an artificial rate. The bank showed its support to the Hong Kong economy by saving its reputation as a financial centre. This was important to HSBC because it still wanted to maintain its legitimacy in Hong Kong. It is suspected that the bank was afraid that its status in Hong Kong would be affected by its rival, BOC, if it did not cooperate with the Hong Kong Government.
6.1.6 1988 New accounting arrangements
The bank paved the way to move to London by gradually stepping away from the responsibility of being the de facto central bank in Hong Kong. The new accounting arrangements in 1988 were the first step to its plan. New accounting arrangements between the government’s Exchange Fund and the bank were introduced in July
1988 by the Hong Kong Government. This involved a contractual agreement between the Financial Secretary, as controller of the Exchange Fund, and HSBC, as
Chapter 6 Accounting in HSBC 1980 – 1996 237 the managing bank of the clearinghouse of the Hong Kong Association of Banks
(mentioned in Section 4.6.2).
Under the previous system, HSBC was the ultimate clearing bank because it did not hold an account with any other entity such as the Exchange Fund. The bank had the power to manipulate short-term money market conditions and took advantage of the interest-free source of funds via the use of the net clearing balance68 (Ho et al.,
1995). However, with the new “accounting arrangements”, HSBC was required to maintain a Hong Kong dollar account with the Exchange Fund and tried to keep the account’s balance equal to the net clearing balance in the local banking system.
HSBC would not receive any interest from the Exchange Fund if it kept a credit balance in the account. But HSBC had to pay interest at a punitive rate to the
Exchange Fund if it kept a debit balance (Freris, 1991b, Jao, 1991, Rafferty, 1989).
On the other hand, the Exchange Fund did not have to pay interest to the bank for credit balances in the account.
68 If HSBC purchased (sold) assets from (to) other banks, it had to credit (debit) the other banks’ accounts and so the net balance would increase (decrease). Banks that ran a surplus could lend to banks that had a deficit. An increase in the net balance would mean an increase in the net supply of liquidity, and the inter-bank rate would fall and vice versa (Jao, 1991).
Chapter 6 Accounting in HSBC 1980 – 1996 238
Figure 6-17 Accounting arrangement in Hong Kong
Exchange Fund
HSBC
Other Other Other Bank Bank Bank
HSBC therefore lost the use of the net clearing balance and profit from the inter- bank transactions. Freris (1991a) suggested that there was an estimated HK$50 million potential loss per annum to the bank of the interest-free use of the net clearing balance. The Exchange Fund actually replaced the bank in the provision of liquidity to the banking system (Ho et al., 1995). However, the Chairman did not mention the possible effect of the new arrangement and defended the new arrangements on the grounds that they would “enable government to have greater control over the supply of money in the inter-bank market and hence over the stability of the link between the Hong Kong and US dollars” (The Hongkong and
Shanghai Banking Corporation Limited, 1989, 10). The bank even explained that they therefore “acquire[d] greater freedom to take positions in the money market”
(The Hongkong and Shanghai Banking Corporation Limited, 1989, 10). The bank claimed that it had no significant net impact on the profitability of the bank's money
Chapter 6 Accounting in HSBC 1980 – 1996 239 market operations, as this potential loss was relatively small compared with the bank’s annual profit. However, HSBC had lost its ultimate power as a clearing bank in Hong Kong.
6.1.7 Move to London
Following the new accounting arrangement, the bank voluntarily registered under the Companies Ordinance and also amended some of its own regulations after an
Extraordinary General Meeting to approve the changes in 1988. The bank previously had been incorporated under its own Ordinance and therefore the provisions of the Companies Ordinance had not applied to the bank except to a very limited extent. “This anomaly had given rise over the years to the perception that the Bank enjoyed a privileged position, even though the differences between the obligations imposed by the Companies Ordinance and the Bank’s own Ordinance were minimal” (The Hongkong and Shanghai Banking Corporation Limited, 1990,
4). HSBC realized that if they wanted to obtain stability and legitimacy in Hong
Kong, they had to conformed with the institutional environment and adhere to external rules and norms (DiMaggio and Powell, 1983, Meyer and Rowan, 1977,
Oliver, 1991). By conforming to the Companies Ordinance, HSBC could enhance its likelihood of survival and demonstrate social worthiness.
In 1989, the bank also stated that the “crisis in China” in June was followed by a significant deterioration in confidence in Hong Kong. However, the bank only mentioned this in one short paragraph in the 1989, under the Chairman’s statement.
This treatment was unlike that for the disturbance in 1967 (refer to Section 5.2.1).
The origins of the 1967 disturbance and its effect on the economy of Hong Kong
Chapter 6 Accounting in HSBC 1980 – 1996 240 warranted almost one full page of discussion in the 1989 annual report. The bank only mentioned the incident in 1989 as a “crisis” in China. However, it was commonly referred to as “the Tiananmen Square protests”, where there were a number of demonstrations and protests by students and labour activists against the
Chinese Government, and a violent reaction by the Chinese Government.
The bank stated the fact that the emigration of skilled and professional people from
Hong Kong had risen since 1987 (The Hongkong and Shanghai Banking
Corporation Limited, 1990). However, the bank emphasized that the number of managers emigrating from the bank actually fell from 67 in 1988 to 63 in 1989, and also dropped 1% as a proportion of a growing managerial work force. They concluded that this indicated that their staff were loyal to the bank. At the same time, the Chairman strongly emphasized that HSBC would be loyal to Hong Kong, and implied China as well. He stressed that he “remain[ed] confident about the territory’s future” and “[the] extraordinary resilience of Hong Kong, and the fundamental importance of its role as the principal economic link between China and much of the rest of the world, will continue” (The Hongkong and Shanghai
Banking Corporation Limited, 1990, 5).
Oliver (1992) proposed that political mechanisms beyond the organization are determinants of deinstitutionalization. DiMaggio and Powell (1983, 154) argued that organizations have a greater ability to resist the demands of organizations which they are not dependent upon. HSBC was not fully dependent on the Chinese
Government for survival. However, with the increasing political pressure from the
Chinese Government, HSBC had to conform with Chinese rule by emphasizing their
Chapter 6 Accounting in HSBC 1980 – 1996 241 loyalty to Hong Kong. On the other hand, the bank wanted to divert its concentration of assets and investment from Hong Kong. In 1990, the bank created a holding company. The Supreme Court of Hong Kong approved a Scheme of
Arrangement pursuant to section 166 of the Companies Ordinance of Hong Kong under which HSBC Holdings PLC became the holding company of the bank. The bank was registered in the UK and its headquarters were located in Hong Kong. All shares were transferred to the holding company, and their shares were listed on both the Hong Kong and UK stock exchanges.
HSBC protected its own interests or viability and accommodated political conflict surrounding the legitimacy of its institutionalized organizational activity (Oliver,
1992). HSBC responded to the changing of political power by moving its headquarters to London. On the other hand, the bank once again emphasized that the restructuring had in no sense diminished its commitment to Hong Kong. They claimed that it “provides a structure that is more appropriate to the group’s various businesses” (The Hongkong and Shanghai Banking Corporation Limited, 1991, 5).
The Hong Kong bank, as a principal subsidiary company, “will remain domiciled in
Hong Kong”. HSBC Holdings PLC, the new holding company, had its headquarters in Hong Kong and was managed and controlled in Hong Kong. HSBC repeatedly expressed its strong commitment to Hong Kong by stating in the annual report that
“its Board and shareholders will meet in the territory; it will be
supervised by Hong Kong’s commissioner of Banking; and its equity
share capital will be in Hong Kong dollars.” (The Hongkong and
Shanghai Banking Corporation Limited, 1991, 5).
Chapter 6 Accounting in HSBC 1980 – 1996 242
When the organization’s legitimacy or survival was threatened with political pressures, it attempted to reduce the extent to which it was externally scrutinized by partially decoupling itself from external contact (Oliver, 1992, Scott, 1987). HSBC straddled two political powers, the East and the West. Therefore, the above statements were issued simultaneously in Britain, just as the London stock market opened (Perkin, 1990, Taylor, 1990, To, 1990b). The bank kept emphasizing that the board and its shareholders would meet in Hong Kong, supervised by Hong
Kong’s Commissioner of Banking and under the HSBC Ltd Ordinance. They claimed that the restructuring could help to reassure the many depositors, banks, shareholders and regulators outside Hong Kong who dealt with the group. HSBC was suspected of avoiding institutional pressures toward conformity by partially
“escaping” from Hong Kong. Avoidance might be motivated by HSBC’s desire to circumvent the conditions that make conforming behaviour necessary (Oliver,
1992).
The move of the bank was broadly commented on in the local and international newspapers for a week (劉詩平, 2007, 馮邦彥, 2002). The then Chairman, William
Purves, explained that he had confidence in “one country, two systems”. But it was built on two assumptions: both parties can understand the relationship, and both parties can think sensibly. If HSBC could not operate smoothly in the international financial market, it weakened the business and even cash outflow to other countries.
In that case, it put pressure on the Hong Kong dollar. It would be too late for the bank to undertake urgent reconstruction one or two years before 1997. Therefore they believed that it was reasonable to prepare early. The Chairman re-emphasized
Chapter 6 Accounting in HSBC 1980 – 1996 243 that they had “informed” China of the move and had not meant to upset China
(Perkin, 1990, To, 1990b). Although HSBC was a private organization, it showed its respect to the authority of the Chinese Government. Under the conditions of uncertainty over the future of Hong Kong during that time, HSBC imitated the behaviour of other actors in the environment. Informing the Chinese Government is a general cultural norm in China. Therefore, HSBC had to conform to this culture to maintain its legitimacy.
Some China analysts suggested that the move was linked to political motivations
(Perkin, 1990). Investors’ reactions to the announcement were reflected in the share market with a drop of 73.77 points, nearly 2.5% on the Hang Seng Index. The banking sector index was also lower. However, the shares were only down 10 cents to $4.65 (To, 1990b). After two days, all the information was digested and the share price rose to $4.85 (Yumol and Wong, 1990). This indicated that local investors had expected key business concerns to take similar post-1997 damage-limitation measures.
The then Governor of Hong Kong, Sir David Wilson, supported the bank and commented that the restructuring was designed to leave the bank firmly committed to Hong Kong. He admitted the fact that the bank had played a major role in clearinghouse arrangements. The Governor and the Hongkong General Chamber of
Commerce believed that the bank would go on playing the role and continue to be the note-issuing bank in Hong Kong (Yumol and Wong, 1990). The bank also got the support of the Senior Executive Councillor, Baroness Dunn, who was also a
Chapter 6 Accounting in HSBC 1980 – 1996 244 director of the bank. Even the managing director of the Hongkong Chinese Bank,
Roger Lacey, thought that it was wise for the bank to choose the UK.
On the other hand, some people were against the move by the bank. Although the
Chairman strongly emphasized that they were “loyal” to Hong Kong, the restructure of the bank actually registered the holding company in London as a low-profile
British non-resident holding company. Some analysts likened it to a Hong Kong resident getting a British passport but still living in Hong Kong (Chow et al., 1990).
The pressure group Meeting Point69 made the criticism that the change would have unpredictable effects on confidence. It also urged the Hong Kong Government to set up an independent investigation group (Yumol and Wong, 1990). The China- aligned Ta Kung Pao (大公報) and Wen Wei Po (文匯報)70 newspapers carried four strongly worded editorials and commentaries about the bank’s move as “not sensible” and “damaging to local confidence” (大公報, 1990, 1, 文匯報, 1990).
They criticized the bank for enjoying privileges in Hong Kong such as note-issuing and acting as a clearinghouse, but not fulfilling their obligations and responsibilities
(Chapel, 1990, Ho, 1990, Taylor, 1990, Young, 1992).
The restructuring of the bank into a British non-resident corporation could perhaps be interpreted as a mimetic process (Chow, 1990). Hong Kong’s oldest British trading company, Jardine Matheson Holdings, took the lead in shifting its legal base
69 Meeting Point was a political party in Hong Kong formed in 1983 which later merged with the then United Democrats of Hong Kong to form the now Democratic Party in Hong Kong in 1994. 70 Ta Kung Pao and Wen Wei Po are two Chinese Government-funded newspapers published in Hong Kong.
Chapter 6 Accounting in HSBC 1980 – 1996 245 and registering in Bermuda71 in 1984, the year in which the Joint Declaration was signed for the return of Hong Kong (Hewett, 1992, Ho, 1990, Nicholls, 1984a,
Patterson, 1996, Rowley, 1996). HSBC’s strategic move away from Hong Kong could possibly give global asset protection to the organization’s interests against the communist incursion after 1997. HSBC also delisted its shares from the Hong Kong
Stock Exchange and traded in Singapore. The bank later relisted its shares in both the London and Hong Kong Stock Exchanges after the restructuring. HSBC was not the first Hong Kong-domiciled bank to move from the threat of China’s anticipated interference after 1997. Asia Financial Co., First Pacific Bank and Dao Heng Bank were financial institutions which were Bermuda-based banks operating principally in Hong Kong (Taylor, 1990). HSBC transformed itself into “one bank, two cultural identities” after the restructure of the bank.
6. 2 Accounting issues
6.2.1 Provision for bad doubtful debts account
HSBC has always made provisions for bad or doubtful debts since 1874. However, the amount set for provision was more than offset by transferring profits in or out from inner reserves during problem years. For example, in 1992, at the time of the confidence crisis over the handover of Hong Kong, and in 1984, at the time of the
71 Bermuda is also regarded by large corporate watchdogs such as Financial Action Task Forces and Transparency International as an “under the radar” banking hub for tax evasion and money laundering. Therefore it is possible that organizations could avoid tax by the strategic move.
Chapter 6 Accounting in HSBC 1980 – 1996 246 collapse of Carrian Group72, HSBC responded to disturbances from the external environment by providing extra provisions for bad debts.
The confidence crisis on the future of Hong Kong broke out among both domestic and foreign investors from September 1982 when Margaret Thatcher, the then
British Prime Minister, visited China for the first time to discuss the 1997 issue and the Tiananmen Square incident. HSBC at this time was walking a tightrope. It needed UK legitimacy and had to give the impression of being affronted by the
Tiananmen Square incident. However, at the same time, it could not afford to offend the Chinese Government. There was strong tension between the West and the East. With the rhetoric of “one country, two systems”, HSBC had to construct a secure image for the public in terms of financial accountability.
The uncertainty caused a fall in the Hong Kong dollar against the US dollar. The
Hang Seng Index of the stock market in Hong Kong fell from 1810 points in 1981 to
901 points in 1982. HSBC was also affected by the stock market slump. The share price of the bank reached a high of over $18 in 1980 and declined sharply in 1982
(King, 1991). This was consistently below book value until the revival in 1986.
The demand for loans increased slowly, with the property market depressed and interest rates remaining low, although the Hong Kong economy was supported by a growth in the China Trade, and domestic exports increased. Therefore, in response to the external disturbance, HSBC had to provide provision for bad debts to meet unexpected loss from the confidence crisis.
72 The Carrian Group was founded in Hong Kong by George Tan, a Singaporean Civil Engineer working in Hong Kong as a project manager for a land development company.
Chapter 6 Accounting in HSBC 1980 – 1996 247
For example, the bank wrote off its provisions for doubtful shipping loans and debts
(US$476 million), incurred by MMBI to developing countries, in order to maintain a sufficient level of capital from the inner reserve in 1984 and 1987 respectively
(Leung, 1992, Taylor, 1992a). The bank also gave a US $200 million injection to
Marine Midland for preserving its capital ratio.
In 1984, HSBC was exposed to serious losses on loans and advances to Carrian
Group. HSBC was Carrian’s main banker and creditor in the early 1980s and
Carrian had used its shares as collateral for loans (Wood, 1982). However, Carrian went bankrupt and collapsed due to allegations of accounting fraud and corruption.
Its share price slumped as the property market became depressed after Thatcher’s visit to Hong Kong. HSBC resisted disclosing the actual potential loss from the
Carrian Group in 1984. HSBC’s Chairman, Sandberg, even commented that it was inappropriate to give exact figures to the public (Nicholls, 1984b). The loss to
HSBC was later revealed to be $679 million (Dobbs, 1986, South China Morning
Post, 1986a, b, Wood, 1982). HSBC considered that if they released the total amount of the loss to the public, the share price of HSBC might fall and its reputation be damaged (Bowring, 1995). Therefore, to maintain its legitimacy,
HSBC had made a provision for bad/doubtful debts when the loss was so considerable, in addition to general provisions for doubtful debts. The bank deducted this provision from advances to customers and other accounts before it published the financial statements. However, the bank did not disclose the actual amount of the provision, and it did not just cover the loss from its inner reserve account. HSBC attempted to reduce the extent to which it was externally evaluated by detaching or decoupling its technical activities from external contact (Oliver,
Chapter 6 Accounting in HSBC 1980 – 1996 248
1991, Scott, 1987). The bank announced that it had taken all possible steps to prepare for the loss from the Carrian Group and made a provision for bad debts.
HSBC’s non-disclosure of the actual amount was a means of maintaining the faith and legitimacy of the bank.
6.2.2 Capital/assets problem- 1980
Capital is important in the banking industry because it could be viewed as a buffer that allows depositors to be paid. If a large borrower went bankrupt and defaulted on a loan, the shareholders must take the loss instead of depositors. The capital ratio in 1979 was relatively low, as shown in Figure 6-18, before any adjustment. HSBC had to pay the transaction cost of the MMBI merger of around $1,500 million, as there was a series of intra-group transactions (The Hongkong and Shanghai Banking
Corporation, 1981). Although it was understood that the ratio had been understated due to the hidden reserves, the capital to assets ratio was a concern even before the payment for MMBI. Even with its inner reserves, the bank was unable to offer scrip on the basis of a prospectus which would be satisfactory to the Securities Exchange
Commission (SEC) because HSBC was acquiring an American bank.
To satisfy the SEC requirement, the capital/assets ratio rose to 5.3%. The bank achieved this ratio by conforming closely to standard practices and re-examining its accounting practices. HSBC reported its “Engagement on behalf of customers” under the shareholders’ fund before 1980. In order to increase the capital/assets ratio, the bank’s assets had included offsetting items (contra accounts) under the general heading ‘Engagements on behalf of Customers’, including acceptance, confirmed credits, guarantees, and the endorsements, which was a standard practice
Chapter 6 Accounting in HSBC 1980 – 1996 249 in the banking industry. With this standard accounting practice, the bank was therefore able to eliminate all of these items, except for “Acceptances”. This totalled $5.8 billion, as state, from its assets. The total amount of assets was reduced from $125.3 billion to $109.5 billion, which was shown in the 1980 annual report, and the capital/assets ratio was raised from 3.3 % to 3.8% (The Hongkong and
Shanghai Banking Corporation, 1981).
The bank changed its accounting practice for recording its fixed assets. Bank premises and equipment were traditionally recorded at cost less the amounts written off because the bank did not deal in real estate. Properties had been written down as quickly as possible to zero and furniture had been written off immediately (King,
1991). An increase in this ratio reflected that the bank was able to continually retain and accumulate more earnings. Therefore, it is normal for banks not to revalue their properties. Even the directors expressed their opinions on this matter in the note of
HSBC’s 1979 annual report, stating that the value of fixed assets was substantially below current market value (The Hongkong and Shanghai Banking Corporation,
1980). However, in 1980, the bank changed these accounting policies and revalued most of the group’s properties in Hong Kong. As shown in note 15 of the 1980 annual report, properties “were valued by the directors at 30 November 1980 on the basis of valuations by independent professional valuers, which were made using open market values based on existing use, or site value where appropriate”
(Hongkong and Shanghai Banking Corporation, 1981, 20). The bank also changed it depreciation policy to depreciate premises at 2% and furniture on a straight line basis over its useful life. The properties were undervalued by $4,415 million and this amount/surplus was transferred to the published reserved fund account. The
Chapter 6 Accounting in HSBC 1980 – 1996 250 bank’s assets had dramatically increased from $125.3 billion, which was shown on the original 1979 balance sheet, to $243 billion at the end of 1980 after the acquisition of over 50% of MMBI equity. Moreover, the bank also established HS
Property Management Company to deal with property through this specialized subsidiary.
In addition, the bank tried to increase its published shareholders’ fund by capitalizing part of its reserve fund. As noted in the Report of the Directors on page
10 of the 1980 annual report, the bank transferred $830 million from the bank’s inner reserves and $209,372,825 from retained profits. The bank also issued additional paid-up capital of $13.9 million to former shareholders of Antony Gibbs
& Sons, Limited with 5,569,636 shares of HK$2.5 each. As a result, the reserved fund account increased from $1,636 million to $7,155.5 million as recorded in the consolidated balance sheet 1980 (The Hongkong and Shanghai Banking
Corporation, 1981).
With the changes in accounting polices for assets, the increase of assets was considerably less than anticipated after the acquisition of over 50% of MMBI equity.
The shareholders’ funds, which included minority shareholders of its major associated companies, increased from $4,178 million in 1979 to $12,894 in 1980
(The Hongkong and Shanghai Banking Corporation, 1981). The capital/assets ratio showed a great improvement from 3.33% in 1979, using historical cost method, to
5.34% in 1980 after all the adjustments in accounting procedures (The Hongkong and Shanghai Banking Corporation, 1981).
Chapter 6 Accounting in HSBC 1980 – 1996 251
HSBC continued its policy of transferring its retained profit to the inner reserve account. The bank had the right issue to improve the capital/assets ratio in 1980.
The decline in the reserve fund in 1981 was due to the drawdown of the Share
Premium Account as the source of funds for the bonus issue. The bank further increased its published shareholders’ funds by transferring from inner reserves, which provided for a net growth of the Reserve Fund and increased its capital to assets ratio.
As shown in Figure 6-18, the slightly improved ratio in 1984 was because of the decrease in the rate of increase in assets. Several bank failures in Hong Kong and a less optimistic atmosphere triggered discussion about new banking legislation which might specify prudential ratios. The bank had had no long-term debt and rights issue since 1921 (King, 1991). The capital accounts in the 1984 annual report comprised debentures, notes and mortgages of subsidiary companies. These subsidiary companies with long-term borrowings included MMBI, Collyer Quay
Properties Ltd, Concord International NV, and the Hongkong Bank of Canada, and totalled $4,438 million. Only HK$984 million was secured. In 1985, the bank changed the title “Long-term borrowings” to “Loan capital”, which consisted of undated primary capital notes issued by HSBC and other loan capital raised by subsidiary companies for development and expansion of the group’s business. The bank borrowed long-term for primary capital of undated floating rate notes at ¼ of
1% over the three-month London Inter-bank Mean Rate totalling HK$6.24 billion and therefore increased the total capital by 20%, and changed the capital/assets ratio from 6.5% to 7.8%. This is shown in Figure 6-18. HSBC had become ‘geared’ for the first time in its history (King, 1991, 885).
Chapter 6 Accounting in HSBC 1980 – 1996 252
Figure 6-18 Capital to assets ratio 1980-1996
Capital/assets ratio 1980 -1996
14.00%
12.00%
10.00%
8.00%
6.00% Percentage% 4.00%
2.00%
0.00%
4 5 6 7 83 8 8 8 8 9 9 9 9 9 1980 1981 1982 1 1 1 1 1 1988 1989 1990 1991 1992 1993 1994 1995 1996 Year
6.2.3 Capital adequacy ratio
A capital adequacy requirement was introduced to Hong Kong as a consequence of the stock market crash in 1987. Historically, banks were required to keep minimum capital standards. However, these requirements were established without regard to a bank’s asset quality, liquidity risk, and other related risks. The new capital adequacy requirement reflected the riskiness of their assets (Heffernan, 1996, Koch and MacDonald, 2006). The capital adequacy ratio is a measure of a financial institution’s net worth as a proportion of total assets, reflecting its ability to bear potential losses without insolvency. The purpose of capital is to provide resources to absorb any losses and by absorbing those losses to protect depositors and potential depositors from loss (Hitchins, et al., 1996, 2001, Koch and MacDonald,
2006, Miller and VanHoose, 2007). Banks have to maintain at least 8% of the capital base to their risk-weighted credit exposures. This was in the Third Schedule
Chapter 6 Accounting in HSBC 1980 – 1996 253 of the Banking Ordinance73. This requirement had applied to Hong Kong since late
1989 after an accord reached by the Basel Committee74 on Banking Supervision in
1988. It served to promote soundness and stability in the international banking system and to reduce sources of competitive inequality among international banks
(Bank for International Settlements, 2008). As Hong Kong is an international financial centre, it was important that it conform with international supervisory standards.
The bank complied with the capital adequacy requirements, which were similar to those agreed in 1988 by the Basel Committee on international capital standards, and disclosed the information from 1989. The requirements divided capital into core capital (Tier I) and supplementary capital (Tier II), and set minimum percentages
(8% for total capital, 4% for Tier I) for the ratio of capital to risk-adjusted assets
(The Hongkong and Shanghai Banking Corporation Limited, 1989).
HSBC expressed its opinion about capital adequacy in its 1987 annual report before the Basel Committee set minimum capital adequacy requirements for banking institutions in 1988. The regulators argued that capital adequacy could help to strengthen the international banking system at a time when the debt problems of less developed countries might have led to public scepticism about the strength of the whole banking system. However, the bank warned that shareholders of banks which had relatively low levels of such debt, for example HSBC itself, were paying a price
73 The statute provides the legal framework for banking supervision in Hong Kong. The Banking Ordinance provides for the authorization and supervision of financial institutions so as to provide a measure of protection to depositors and to promote the general stability and effective working of the banking system. 74 The Basel Committee is a group of 10 central banks which set out the guidelines for international convergence of capital measurement and lay down standards.
Chapter 6 Accounting in HSBC 1980 – 1996 254 for higher capital-asset ratios in terms of business opportunities forgone because of the constraint on asset creation. HSBC had a history of low capital to assets ratios
(refer to section 5. 4). Therefore, the bank strongly opposed the new regulation.
They explained that there was an added complication of capital denominating in the
Hong Kong dollar, a relatively weak currency, and the whole value was correctly linked to the US dollar. The bank emphasized their strategy of linking their value to a stronger currency, the US dollar. Therefore the bank had to restrict its asset growth because any fluctuation of foreign currency would affect the value of the bank. The chairman explained that they had redoubled their effort to ensure that only facilities with an adequate level of profitability were written, and to increase non-interest income as a proportion of the group’s revenue. The bank did not disclose the capital adequacy ratio in 1991 due to the loss for the year and the reorganization of the organization. During that time, it was not compulsory for the bank to disclose the capital adequacy ratio to the public.
Although HSBC did not welcome the capital adequacy requirement, it was subject to capital adequacy controls similar to those agreed by the Basel Committee on international capital standards. The new capital adequacy requirements came into effect in September 1989. Banks are subject to capital adequacy controls similar to those agreed in 1988 by the Basel Committee on international capital standards. The bank started to disclose its capital adequacy ratio from 1989. The capital to risk- weighted assets from 1999 gradually rose from 10.8% in 1989 to 15.4% in 1996
(refer to Figure 6-19).
Chapter 6 Accounting in HSBC 1980 – 1996 255
Figure 6-19 Capital/risk-weighted assets 1999-1996
Captial/risk-weighted assets 1989-1996
20.0
15.0
10.0
5.0 Percentage % Percentage
0.0 1989 1990 1991 1992 1993 1994 1995 1996 Year
6.2.4 Changes in accounting methods
A number of changes in accounting methods were shown in the HSBC annual report after the 1987 stock market. In 1987, the deferred taxation was provided on timing difference, using the liability method, between the accounting and taxation treatment of income and expenditure. According to the annual report in 1987, the Board of
Directors expressed their opinion that no liability to taxation was expected to arise in the foreseeable future (The Hongkong and Shanghai Banking Corporation, 1988).
This indicated that the directors could choose the accounting methods to conceal any potential tax liability.
Secondly, the bank clearly defined its finance and operating leases in the 1987 annual report, which affected the figure of the “Advances to Customers” and
“Current, Deposit and Others” accounts. The notes stated the classification of finance leases as assets leased to customers under agreements which transfer substantially all the risks and rewards associated with ownership, other than legal title. The amount due under the leases as a lessor was included in “Advances to customers” and other accounts. Finance charges receivable were recognized over
Chapter 6 Accounting in HSBC 1980 – 1996 256 the periods of the leases in proportion to the funds invested. The leased assets were capitalized and included in ‘Furniture, plant and equipment’ and the corresponding liability to the lessor was included in ‘Current, deposit and other accounts’ when the group was a lessee under finance lease. Rental payable and receivable under operating leases was accounted for on the straight line basis over the periods of the leases. Because of the changes in reporting methods, “Advances to Customers” account increased by 30%, and the “Current, Deposit and Other” accounts increased by almost 35% from HK$249,398 to HK$335,469 (The Hongkong and Shanghai
Banking Corporation, 1988).
Thirdly, changes took place in disclosing loans to officers: the bank disclosed loans to officers according to section 161B of the Companies’ Ordinances from 1994 onwards. The list included the individual names, terms75, beginning balances and ending balances of the year, types of security76, and the maximum balance outstanding during the year. However, from 1987 onwards, the bank only disclosed the particulars of loans to officers of the bank, which included the aggregate amount of loans at the end of the year and the maximum aggregate amount of loans outstanding during the year. The total amount of loans outstanding increased from
HK$33.7m to HK$41.6m, and the maximum aggregate amount of loans outstanding increased by 26% from 1986 to 1987. The reason for the change may be due to the stock market crash because the bank did not want to disclose the types of loans to its shareholders. HSBC engaged in a symbolic acceptance of institutional requirements by only disclosing the aggregate amount of the loan. The bank might have
75 Examples of term of loans: overdraft/employee housing loan/letter of credit, and rate of loans. 76 Type of security: unsecured/property/shares and unsecured property/cash deposit.
Chapter 6 Accounting in HSBC 1980 – 1996 257 considered that the appearance rather than the fact of conformity is sufficient for the attainment of legitimacy (Oliver, 1991).
Fourthly, retirement benefits were first introduced in the 1987 annual report as a note under the principal accounting policies even though there was no mandatory requirement for disclosure. The bank particularly mentioned that the arrangement for staff retirement benefits varied from country to country and decisions were made in accordance with local regulations and custom. The funds for retirement benefits would be valued at least once every three years and annual profits charged with contributions at rates, based on actuarial advice, and related to projected salaries at the date of retirement. However, the bank did not disclose the actual amount of these retirement benefits in the annual report. HSBC again considered it was important to appear to conform in order to maintain legitimacy.
Lastly, the bank disclosed that the amount of HK$2,100m had been debited to the inner reserves before the published net profit. The bank had provided an additional provision against the debt to less developed countries’ made by Marine Midland
Bank, Inc. The published net profit was also calculated after the changes in value of assets and differences arising from the revaluation of foreign currencies.
6.2.5 Off-balance sheet items
Off-balance sheet items were becoming more important at banks. Off-balance sheet financial instruments were first introduced into the financial report of HSBC in
1993. It explained that off-balance sheet items included futures, forward, swap and
Chapter 6 Accounting in HSBC 1980 – 1996 258 option transactions undertaken by the group in foreign exchange interest rate and equity markets (The Hongkong and Shanghai Banking Corporation Limited, 1994).
Off-balance sheet items are contingent assets and liabilities. These assets and liabilities represent payments to or from the bank due at some future date that potentially can produce positive or negative future cash flows for a financial institution (Koch and MacDonald, 2006, Saunders and Lange, 2001). Off-balance sheet assets are activities that move onto the asset side of the balance sheet when a contingent event occurs. Off-balance sheet liabilities are activities that move onto the liability side of the balance sheet when contingent events occur (Koch and
MacDonald, 2006, Saunders and Lange, 2001). These items include commitments and guaranties that take the form of loan commitments, standby letters of credit, commitments related to interest rate swaps, futures and forward contracts, swaps and options, currency exchange, and insurance on securities.
The accounting for these instruments for HSBC is dependent upon whether the transactions are undertaken for dealing purposes, to hedge risk, or as part of the management of assets and liability portfolios. Transactions for dealing purposes were using market value and the net present value of the gain or loss arising was recognized in the profit and loss account as dealing profits, after appropriate deferrals for unearned credit margins and future servicing costs. HKMA did not set any guidelines on risk management on derivatives until 1998 after the financial crisis in 1997. HKMA tightened disclosure about the risks run by financial institutions (Carse, 1998). Therefore, HSBC used the disclosure of its off balance
Chapter 6 Accounting in HSBC 1980 – 1996 259 sheet activities in the annual report to maintain legitimacy and project an image to the public that it was financially sound.
6.2.6 Taxation issues
Being a non-resident British incorporated company, the bank could move its base of incorporation to Britain without being hit by British corporate tax rates. In such a case, the bank could provide the tax protection needed for its shareholders. It has long been an effective vehicle for companies offshore from Britain who wanted to have a British-registered company as a base, without being taxed by the British
Government (Perkin, 1990). Several well-known Australian entrepreneurs, such as
BHP Billiton, are known to have used such corporate vehicles in their dealings in
Britain, while being based in Australia. The British Government tightened the rule in 1988 that all British incorporated companies would have British residency for tax purposes, even if the control and management were outside Britain. However, there would be an exemption from this rule for a limited time span which gave entities five years to “phase out”. The second exception was given to those companies which were created before 1988, were carrying on business, and had received a government agreement to be regarded as managed and resident outside Britain, and have their income taxable in the country in which they were managed. HSBC managed to maintain its Hong Kong tax status while effectively using a British incorporated entity as its new holding company (Perkin, 1990). HSBC embodied the rhetoric of “one bank, two cultural identities”.
Chapter 6 Accounting in HSBC 1980 – 1996 260
6.2.7 Disclosure of the inner reserve
Prior to 1994, banks in Hong Kong were allowed to maintain inner reserves (also known as hidden or secret reserves) and published very limited information in their annual financial reports by a special provision in the Hong Kong Companies
Ordinances (1990) and Statement of Standard Accounting Practices (SSAPs). The lower the degree of legal coercion behind institutions’ norms and requirements, the greater the likelihood of an organization’s resistance to institutional pressures
(Oliver, 1991). Without regulations to govern the inner reserve account, HSBC chose not to disclose their secret reserve. They did not have to provide a breakdown of income, operating expenses, and the charge for bad and doubtful debts in their statement of profit and loss. Profits and net profits were shown after transfer to or from inner reserves. Most banks had an inner reserve account in the item “Other
Accountings and Provisions” on the Statement of Financial Position, which might include provisions for taxation and retirement benefits. The rationale behind this, according to Raymond Li (Li, 1999), was to avoid disclosing losses or a sharp fall in profits which might jeopardize confidence in the bank concerned, and in the stability of the whole financial system in Hong Kong. Banks could increase reported liabilities through excessive provision for expenses or decreasing reported assets through underreporting of revenues. Some banks used it as an income-smoothing method and to absorb losses, manage assets and meet capital adequacy requirements.
Therefore, a bank’s published profits calculated when inner reserves were used would not be the same as profits calculated under generally accepted accounting principles. Investors also found it difficult to detect the inner reserve transfers in or out from the changes in the totals of account.
Chapter 6 Accounting in HSBC 1980 – 1996 261
HSBC held an “inner reserve” account before 1993 (Chan and Khoo, 1998, Ho,
2001, Krpszner, 1990, Stein, 1994). The bank had long been using the inner reserve account and this was known to the public. For example, in 1979 the bank announced a six-month profit of $432.36 million after tax and the “usual undisclosed transfers”, which was reported in the newspapers of in Hong Kong
(Nicholls, 1979).
Public awareness of the information provided in the annual reports was triggered by the stock market crash in October 1987. In 1987, the bank was given honourable mention for the high standard of its reports at the Hong Kong Management
Association’s best annual report awards (Hong Kong Standard, 1987). The judges noted there was a trend among some companies to mislead the reader by including pictures of whole buildings in which they only had a small interest. This problem was worsened when HSBC acquired MMBI. HSBC bought out the minority shares of Marine Midland Bank in 1987, which generated goodwill of HK$3 billion.
However, it was not written off through the profit and loss statement but taken directly to inner reserves (Cottrell, 1988, Leung and Zhao, 2001). The bank also never disclosed the profit earned by its clearing operations for every cheque it cleared. It did not take into account its ability to play a currency and interest rate market which it had considerable power to influence (Taylor, 1992a).
In response to public criticism, HSBC first included an explanation of the “inner reserves” in the notes of accounts under principal accounting policies in 1988. The bank indicated that it wanted to bring itself more into line with international standards (Marray, 1989, Winn, 1989). However, analysts believed that it was
Chapter 6 Accounting in HSBC 1980 – 1996 262 related to the merger with the Midland Bank, a UK bank, and a concern for international practice. It was also suspected that with the new accounting arrangement (discussed in section 6.1.6), HSBC lost its power as the ultimate clearing bank in Hong Kong. Therefore, it had to release the information of its inner reserves account to project an image as a sound and reliable bank, and maintain its legitimacy in Hong Kong. HSBC explained that the maintenance of inner reserves was ‘permitted by the Companies Ordinance’ and ‘transfers to or from inner reserves are made within guidelines set by the Board of Directors’ (The Hongkong and Shanghai Banking Corporation Limited, 1989, 44). Inner reserves were included in the balance sheets in ‘Current, deposit and other accounts’ and separately. The group maintained inner reserves in addition to published reserves in
1989. The bank provided more details of the reserves account than in previous years. The amount of published inner reserves was included in ‘Current, deposit and other accounts’ in the balance sheet and details were provided of how the amount was allocated to the reserves account.
Although HSBC, the holding company, was under the British Companies Act, which imposed some higher disclosure requirements, this did not have any effect on the bank’s 1990 accounts. Chapel (1990) commented that the absence of detailed published accounts has tended to exaggerate the effect of the mostly bad overseas news. Some securities analysts also argued that international investors would look at a detailed bank disclosure more seriously and be able to compare it with other international banks more easily.
Chapter 6 Accounting in HSBC 1980 – 1996 263
The practice of inner reserves in Europe started to change in 1991. The British Bank
Account Regulation in 1991 ended the practice of inner reserves because of increasing demands by investors for operating transparency in financial institutions.
However, the regulatory change did not take place in Hong Kong until 1994, due to pressure from the change to International Accounting Standards. HKMA encouraged and required banks to publish more information in their financial reports. Profits were no longer shown after transfer to inner reserves and all reserves had to be disclosed. Banks had to disclose their inner reserve transfers in 1994 and inner reserve balances in 1995 annual reports and close the inner reserve account.
The changes were in response to institutional pressure, and International Accounting
Standard (IAS) No.30 (reformatted 1994), which called for greater disclosure by financial institutions.
A report from an international credit rating agency, Capital Information Services, found the bank’s disclosure of information to be the second-lowest in Asia, only just ahead of China in 1991 (Fung, 1993). Some financial analysts also commented that the disclosure of information in Hong Kong had always been minimal and did not improve at all. They were also concerned about whether the banks were following international accounting standards in revealing items, and that they might suffer a poor image abroad among other regulators and rating agencies (The Banker, 1994).
HKMA’s executive director (banking supervision) defended them, saying that they collected information on various aspects of the bank’s activities and believed that adequate information was available for them. Hong Kong corporations had to follow the UK accounting standards which closely follow the International Standard.
However, this left the public at the mercy of supervisors because the government
Chapter 6 Accounting in HSBC 1980 – 1996 264 kept details secret. The Hong Kong Government allowed banks to direct part of their profit to hidden inner reserves. Under pressure from different parties in public, the result of this debt was that the Banking Commissioner released a guideline on the use of inner reserves in 1993 to ensure that banks did not paint a rosy picture after a bad year (Fung, 1993).
Although no regulation was imposed in Hong Kong, HSBC revealed its inner reserves in 1992 after a European community directive77 (Leung and Zhao, 2001).
This is consistent with the mimetic view of conformity by an organization.
Therefore, HSBC imitated the behaviour of other banks in Europe, particularly those banks which they knew were trusted. HSBC conformed with public expectation and disclosed the inner reserves in 1992.
The bank voluntarily revealed its inner reserve totalling HK$25.3 billion when it merged with Britain’s Midland Bank in 1992. It comprised HK$16.6 billion in cash,
HK$6.7 billion in unrealized investment gains, and HK$2 billion in valued (Leung,
1992, Stein, 1994, Taylor, 1992b). The bank also disclosed that the revaluation of the group’s property and long-term investments amounted to HK$8.7 billion, which were recorded at below market value in the past. The bank also disclosed that they wrote off provisions against debts.
The bank claimed that “following the decision of the Board of the Bank to disclose inner reserves, the consolidated balance sheet of the Group and the balance sheet of the bank as at 31 December 1991 have been restated to reflect the reclassification of
77 For example, Deutsche Bank voluntarily adopted IAS No.30 and abandoned inner reserves in 1995 Accountancy 1996. Deutsche Banks Move to IASs Accountancy, 117, (7)..
Chapter 6 Accounting in HSBC 1980 – 1996 265 inner reserves from current, deposit and other accounts to reserves and minority interests as appropriate” (The Hongkong and Shanghai Banking Corporation
Limited, 1993, 15). The move of HSBC to disclose its inner reserve, or disclose profits as they were earned without transfers to and from reserves, upset the right of local banks to keep theirs secret. The disclosure of the inner reserve put pressure on other local banks to list theirs. If other local banks wanted to survive and avoid public criticism, they might have to follow the more successful organization in the same industry to disclose their inner reserve as well (Oliver, 1991). Therefore, locally incorporated banks, such as members of the BOC group78, defended their rights to keep secret reserves. They resisted the abolition of their rights to hold inner reserves. They stressed that locally oriented banks were more vulnerable to changes in the economy than internationally oriented banks. Therefore, they should have the right to decide on whether they should unveil their inner reserves (To, 1989).
Secret reserves were more important for locally oriented banks in smoothing out the results than those with extensive international operations. Local banks were vulnerable to the ebb and flow of local business cycles which in large part were beyond their control. However, it would increase protection for bank depositors if secret reserves were to end (South China Morning Post, 1990, To, 1990a).
After the disclosure of its inner reserve, HSBC was cited in the report done by
Deloitte Touche Tohmatsu in 1999 as providing the most comprehensive levels of disclosure, particularly in the areas of credit exposure and risk management. The bank also provided a comprehensive review of advances to customers and
78 Nanyang Commercial Bank, Po Sand Bank, Hua Chiao Commercial Bank and Chiyu Banking Corp.
Chapter 6 Accounting in HSBC 1980 – 1996 266 provisions against advances to customers. The differences between the definitions of categories of advances used by the bank and the HKMA, and the definitions of rescheduled advance, were also included the annual reports (Cheung, 1999, The
Hongkong and Shanghai Banking Corporation Limited, 2000). HSBC had successfully used its financial reporting to maintain its legitimacy in Hong Kong.
6.2.8 Political issues
The bank had traditionally been represented in the Executive Council (Execo), Hong
Kong’s highest policy-making body presided over by the Governor. The position had enabled the bank to influence and be informed of the government’s key economic policies (Chan, 1990). A liberal pressure group and the Association for
Democracy and People’s Livelihood had urged the government to review the bank’s privileges and questioned whether the bank should continue to be allowed a seat in the Execo. This was considered as a disturbance to the bank which would affect their legitimacy in Hong Kong. Therefore, HSBC might attempt to balance or bargain with external constituents, the Chinese Government, in order to enhance its legitimacy and social support (Oliver, 1991).
The chairman of the bank, Mr. Purves, had a meeting with the Chinese Prime
Minister Mr. Li Peng on 6th October 1989 after the Tiananmen Square incident (Lee and Yeung, 1989). The Tiananmen Square incident was particularly sensitive for the Chinese Government. On the one hand, the Chinese Government was afraid that foreign investments would move away from Hong Kong because of uncertainty over its future. On the other hand, HSBC would like to establish a steady relationship with China. During the meeting, the bank gave assurances that it wanted to continue
Chapter 6 Accounting in HSBC 1980 – 1996 267 to play an important role in Hong Kong’s international economic life. However,
HSBC moved its headquarters to London in the following year.
The political influence of HSBC could further been seen from its role in the Hong
Kong Association of Banks (HKAB). HKAB, which was incorporated by statute, replaced the old Exchange Bank’s Association as the representative organization for the banking industry in Hong Kong in 1981. This formalized the government’s consultative role in the determination of deposit interest rates as well as constituting the first step by the government to update legislation affecting the financial sector generally. As mentioned in 4.6.2, HSBC and the Standard Chartered Bank chaired the HKAB in alternate years. Because of its control over foreign exchange, the government committee and other members of the bank were usually afraid to oppose the decisions made by HSBC. Therefore it may be concluded that HSBC had the ultimate control of the HKAB (劉詩平, 2007, 216). HSBC’s Chairmen and other managers were executive members of the Executive Council79 and the Legislative
Council80 of Hong Kong. For example, Miss Lydia Dunn was appointed as the first woman on the board of HSBC in 1981. She sat on Swire’s board and on the
Legislative Council and was the Chairman for the high-level Special Land
Committee (South China Morning Post, 1981). Therefore, the bank involved in the policy making procedures which included financial issues (劉詩平, 2007, 217). The bank also had to adjust to the new three-tier system of banking. It could be argued
79 The Executive Council is an organization for assisting the Chief Executive in policy making. 80 The Legislative Council is the unicameral legislature of Hong Kong.
Chapter 6 Accounting in HSBC 1980 – 1996 268 that before the handover of Hong Kong to China, HSBC was still a dominant force in Hong Kong society .
6. 3 Three years before the handover
In 1994, the Chairman of the bank, JM Gary, commented in the Chairman’s report that a degree of uncertainty was inherent in an unprecedented transition but Hong
Kong nevertheless continued to perform remarkably well. He also emphasized that the attention being given to the discord in the political arena should not be allowed to obscure the solid progress that had been made at all levels in other areas.
Although the bank had implied that all the Board meetings would be held in Hong
Kong, the Board meeting in 1994 was held in Shanghai. This was the first time that the Bank’s Board had met outside Hong Kong since the Second World War. They considered it was appropriate to convene in the city from which the Bank derived part of its name and in which it had remained open for business since the year of its founding. This symbolized that the bank had a closer relationship with China and gave confidence to its stakeholders. It was also the first time in the Chairman’s statement that business in China was placed before that of Hong Kong (The
Hongkong and Shanghai Banking Corporation Limited, 1995).
Even the theme of the annual report in 1994 represented the daily business of the bank, featuring various aspects of its wide-ranging operations in the Asia-Pacific region. It also indicated that the position of Hong Kong enabled business to be conducted continuously between the three cities, London, New York and Hong
Kong, enhancing Hong Kong’s position as one of the world’s principal financial
Chapter 6 Accounting in HSBC 1980 – 1996 269 centres and an important link between East and West (The Hongkong and Shanghai
Banking Corporation Limited, 1995).
The format of the annual report changed from 1994 onwards. The first page of the financial reports gave the financial highlights of the bank. It included the risk- weighted assets and ratios with the Hong Kong dollar, the pound and the US dollar.
The risk-weighted assets disclosure was a compulsory requirement of the Banking
Ordinance. It also included a detailed financial summary which gave extra information and explanation of the financial results. For example, the net charge for doubtful debts had dropped sharply from HK$3,850 million in 1993 to HK$174 million in 1994 (The Hongkong and Shanghai Banking Corporation Limited, 1994).
The bank produced an impressive figure of a sharp downward sloping line of provisions for doubtful debts. It explained that they have improved in the quality of the loan book. However, it was not consistent with the amount shown on the notes of account.
Moreover, under the notes on premises and equipment, HSBC specially indicated that premises and investment properties were revalued by independent professionally qualified valuers at open market value for existing use or, in the case of the few specialized premises, at depreciated replacement cost (HSBC, Annual
Report, 1994). In determining the subsequent permanent diminution in value of certain premises, principally in Japan, the directors had been advised by the group’s professionally qualified staff and by professional external valuers. The bank also included foreign currency amounts on sterling and the US dollar. For the profit and loss account, HK dollars were translated at the average rates of exchange for the
Chapter 6 Accounting in HSBC 1980 – 1996 270 year. For balance sheet items, HK dollars were translated at the rate of exchange ruling at 31st December 1994 (The Hongkong and Shanghai Banking Corporation
Limited, 1995).
6.3.1 Additional summary of financial performance
The bank listed a number of ratios on the first page of the annual report from 1994, which is three years before the handover. These ratios included return on average shareholders’ funds, post-tax return on average total assets, cost to income ratio, net interest margin, and capital adequacy ratios.
Many assets held by banks are peculiar to the banking industry. Assets include cash held, deposits held with other banks, securities and bonds, loans, interest receivable, and branches (Frost, 2004). For banks, all items that the banks owe are treated as liabilities. The largest liability class is the deposits from customers. Other liabilities include deposits from non-bank customers and banks, interest payable, long-term financing such as bonds issued and subordinated debt.
6.3.2 Influence of the Chinese culture
Chinese culture was slowly incorporated into the annual report of HSBC. In 1995, there was some Chinese written in the English version of the annual report. The theme of the 1995 annual report was the way HSBC was meeting its responsibilities to the community it served. The Chairman once again emphasized that the bank’s confidence in Hong Kong was undiminished and they had a close relationship with
China. The bank gave a number of their executives the opportunity to expand their knowledge of China by attending a familiarization programme at Tsinghua
Chapter 6 Accounting in HSBC 1980 – 1996 271
University in Beijing. It addressed the issue that China had reformed its financial system and promulgated new laws in 1995 which formed the foundation of a modern commercial banking sector. Therefore, it was important to understand fully the major challenges facing the country and the progress it was making in meeting them. The initiatives typified the cooperation which existed at many levels between
China and Hong Kong (The Hongkong and Shanghai Banking Corporation Limited,
1996, 6).
The bank appointed its first Chinese general manager, Vincent Cheng Hoi-Chuen,
OBE, JP, in 1995 (Bashford and Hewett, 1995, Cruz, 1995b). Prior to this it was said ‘not a single ethnic Chinese has executive responsibility on the Hongkong Bank board’ (Taylor, 1992a, 40). Localization took place in 1995 when the local staff were in charge of personnel, corporate banking/retail banking, China operations and a local staff member was appointed the chief financial officer. Mr. Cheng joined the bank in 1978. He was seconded to the Hong Kong Government’s Central Policy
Unit and was an adviser to the Governor of Hong Kong. He was the bank’s chief financial officer in 1994 and became a group general manager, the bank’s highest ranking ethnic Chinese, in 1995 (Cruz, 1995b).
The bank expanded its businesses into central and western China after the banking reforms which opened up foreign investment (Cruz, 1995a). The bank was only allowed to have representatives in China rather than branches. The Chinese government opened up foreign investment by passing China’s central bank law, commercial bank law, and negotiable instruments law, which paved the way for the bank’s expansion (Cruz, 1995b). Sir William Purves said he regretted that more
Chapter 6 Accounting in HSBC 1980 – 1996 272 localization had not taken place during his time with HSBC (Bashform and Hewett,
1995). However, progress had been made to achieve a greater balance with the appointment of Vincent Cheng to the main board of the group.
One year before the handover, the theme of the bank’s annual report was that the future lay in its status as a SAR of the People’s Republic of China. The whole volume was related to China and not global. “Detailed constitutional arrangements guarantee the territory a high degree of autonomy and will preserve its thriving market economy. At the same time, Hong Kong owes much of its success to its growing interdependence with the Mainland. The process of integration is reflected in mutual trade and investment, in the development of transport and tourist infrastructure, in the distribution of supplies and utilities, in the broadening of technology links, in the growth of the consumer market, and in an increasing number of cultural, academic, social welfare and artistic exchanges” (The Hongkong and Shanghai Banking Corporation Limited, 1997b, 3).
HSBC emphasized its close relationship with mainland China. In the Chairman’s and Chief Executive’s introduction to the annual report in 1996, they stressed that the bank had been granted the approval of the People’s Bank of China (PBOC) to upgrade their representative office81 in Dalian to a branch. It had also received permission from the PBOC to relocate its Shanghai branch to the Pudong district82 and approval to conduct renminbi business in Shanghai. When China began open market operations in 1981, the first foreign branch banks were allowed to operate in
81 A representative office is any office of a foreign bank that is located in any country and is not a branch or a foreign bank. Only a foreign branch bank can offer services such as loans to their multinational corporation customers. 82 Pudong is the central district of Shanghai and it is where the first HSBC office was located.
Chapter 6 Accounting in HSBC 1980 – 1996 273 the special economic zones, e.g. Shenzhen (Lardy, 1998, 2002). The Heng Sang
Bank, HSBC’s subsidiary, established its presence in mainland China when it opened a representative office in Shenzhen in 1985. Later in the early 1990s,
Shanghai and a few other major cities were opened to permit foreign banks to operate and the bank opened its first branch in Guangzhou. The mimetic force can be seen in the opening of branches in China.
6.3.3 Change of accounting standards in Hong Kong
The coercive force, in the form of accounting standards, can be seen from the changes in HSBC’s annual reports. For example, HSBC was the first bank in Hong
Kong to introduce Cash Flow Statements in the annual report. In order to comply with the accounting standard SSAP15 Cash Flow Statements of 1994, the bank published its first Cash Flow Statement in its annual report in 1995.
Moreover, there was a change in the accounting policy for investment properties. In the notes on account for tangible fixed assets, HSBC stated that premises were revalued by professionally qualified valuers with sufficient regularity to ensure that the net carrying amount did not differ materially from the fair value (The Hongkong and Shanghai Banking Corporation Limited, 1995). HSBC was using professionally qualified valuers for legitimacy. HSBC also explained in the annual report that any surpluses arising on revaluation were transferred to the ‘property revaluation reserve’. Deficits arising on revaluation were recognised as expenses except to the extent that they reversed surpluses previously recognized on the same properties, in which case they were deducted form the ‘Property Revaluation Reserve’.
Chapter 6 Accounting in HSBC 1980 – 1996 274
In addition to this, HSBC followed the adoption of the Hong Kong Statement of
Standard Accounting Practice 13 on ‘Accounting for Investment Properties’, where no depreciation is provided on investment properties other than leaseholds with 20 years or less to expiry. However, before the adoption of the new regulation, these items were depreciated on a straight line basis over the unexpired terms of the leases. The Board of Directors considered the amounts to be immaterial and therefore no prior period adjustment was made. Investment properties were revalued on an annual basis from 1994 onwards. Previously, investment properties were revalued every three years. HSBC conformed with generally acceptable accounting practice in recording their investment properties account.
HSBC also changed its accounting policy for depreciation of long leasehold land.
Following the implementation of Hong Kong Statement of Standard Accounting
Practice 17 on ‘Property, Plant and Equipment’, the bank had provided depreciation on long leasehold land on a straight line basis over the unexpired terms of the leases.
The bank had not depreciated leasehold land with more than 50 years to expiry before the implementation of the new regulation. According to the decision of the directors, no prior year adjustment was made because they considered the additional depreciation was immaterial. However, if HSBC wanted to survive and maintain its legitimacy, it had to conform with the accounting standards.
Chapter 6 Accounting in HSBC 1980 – 1996 275
Coercive forces also came from legal requirements. Retirement benefits were detailed in the annual report. The Occupational Retirement Schemes Ordinance83 required retirement benefit schemes in Hong Kong to be fully funded on a wind-up basis by October 1998. This can also be considered as a coercive force for HSBC to conform to legal requirements. The Ordinance requires any deficits on an ongoing basis to be eliminated over a period of time in accordance with the funding recommendations of a qualified actuary. The costs of the two defined benefit schemes described below are assessed so as to recognize the cost of retirement benefits on a systematic basis over employees’ service lives and take into account the relevant provisions of the Occupational Retirement Schemes Ordinance.
With the Banking Ordinance, HSBC had to disclose the capital adequacy ratio. This ratio was calculated in accordance with the Third Schedule of the Banking
Ordinance, and a minimum liquidity ratio or 25% in accordance with the Fourth
Schedule of the Banking Ordinance.
To sum up
This chapter discussed HSBC’s financial reporting changes between 1980 and 1996.
HSBC went through tremendous political change and external disturbances. HSBC again had to struggle with disturbances that emanated from both internal pressure
(the acquisition of MMBI and establishment of HSBC Holding) and external
83 The Occupational Retirement Schemes Ordinance (ORSO) came into force on 15th October 1993, and is the governing legislation for the regulation of voluntary occupational retirement schemes operating in or from Hong Kong. The ORSO aims to regulate the retirement schemes industry through a registration system to ensure that all voluntarily established occupational retirement schemes are properly administered and funded, and to provide greater certainty that retirement scheme benefits promised to employees will be paid when they fall due (http://www.mpfahk.org/english/orso/orso_ors/orso_ors_orso/orso_ors_orso.html).
Chapter 6 Accounting in HSBC 1980 – 1996 276 pressures (banking crisis in early 1980s, the stock market crash in 1987, and the
1997 Confidence crisis). HSBC started to emerge as “one bank, two identities”.
Because of the acquisition of MMBI, HSBC had to comply with the SEC requirements. This coercive pressure influenced HSBC’s accounting practices. In order to maintain its legitimacy, HSBC changed its revaluation method for fixed assets and depreciation of assets to satisfy SEC requirements on the capital to asset ratio. HSBC also had to respond to tightened regulatory requirements after the 1987 stock market crash. Although HSBC strongly opposed the new capital adequacy requirements of the Banking Ordinance, it had no choice but to comply and maintain a minimum required ratio. HSBC used annual reports to express its opinion and communicate with its shareholders. The bank used this as an excuse for the future loss of profit, because it had to forgo business opportunities to maintain a high capital to assets ratio.
The acquisition of MMBI and the new accounting arrangement paved the way for
HSBC to become a multinational corporation. During the time of uncertainty and the negotiation over the future of Hong Kong between the British and Chinese
Governments, HSBC had to response strategically to maintain its legitimacy. In response to this external disturbance and political pressure, HSBC moved its headquarters to London in 1990. The restructure of the bank can be explained by this mimetic force, and an active response to decouple from external disturbance
(Powell and DiMaggio, 1991, Oliver, 1991, Scott, 2001). HSBC registered in
Britain and managed to maintain its Hong Kong tax status as the tax rate in Hong
Kong is lower than in Britain.
Chapter 6 Accounting in HSBC 1980 – 1996 277
In addition, the changes in the inner reserves account also reflect institutional pressures on HSBC. HSBC had kept a secret reserves account, as a traditional
British/Scottish bank, from the time of its establishment in Hong Kong. Although the public became aware of the disclosure requirements of financial institutions after the stock market crash in 1987, HSBC resisted disclosure of its inner reserve account. Instead of disclosing the actual amount of the account, HSBC just mentioned that they had transferred annual profit to their inner reserves account before publishing the financial statements. HSBC symbolically accepted the institutional pressure by merely showing the appearance of disclosure of the inner reserves account, without any substance. However, HSBC responded to the mimetic force of the European trend of disclosing inner reserves accounts. The bank voluntarily disclosed its inner reserves account in 1992, although the legal requirement only came into force in Hong Kong after 1994. HSBC used its disclosure of the inner reserves account to maintain its legitimacy in Hong Kong.
Chapter 7 Accounting in HSBC 1997 - 2004 278
CHAPTER 7 ACCOUNTING IN HSBC 1997 – 2004
1997 was an important year for Hong Kong. The sovereignty of Hong Kong was handed over to China on 1st July 1997. Many people expected that there would be a great change in Hong Kong. However, Christopher Francis Patten, the then and last
Governor of Hong Kong, commented that “some Chinese may have been surprised to find Hong Kong in such fine shape [after 1997]. Its huge reserves had not been shipped back to London in Britannia’s hold. Nor had Hong Kong’s fiscal surpluses been dissipated on schemes that would prove popular in the short term but unaffordable in the longer term. They had certainly not been handed out in payments to British firms for contracts unfairly awarded” (Patten, 1998, 85-86) . He also argued that “British companies, like all others, operated on a level playing field, in which the award of contracts was overseen by both the Independent Commission against Corruption and the public auditor” (Patten, 1998, 86).
Major changes took place in the banking industry of Hong Kong. These changes actually took place from 1993 onwards, especially after the establishment of the
Hong Kong Monetary Authority (HKMA). As mentioned in chapter six, HSBC was no longer the de facto bank of Hong Kong and the Bank of China (Hong Kong) became the third note-issuing bank. The British no longer dominated the banking industry in Hong Kong. Specific disturbances of the Asian financial crisis in 1997, which triggered the tightening of regulatory requirements from 1997 onwards, are discussed in section 7. 1. Section 7.2 discusses some of the key performance indicators of HSBC during 1997-2004, including the capital adequacy ratio in section 7.2.1, liquidity ratio in section 7.2.2, return on average shareholders’ funds in section 7.2.3, and net interest margin in 7.2.4. Section 7. 3 discuss the changes in
Chapter 7 Accounting in HSBC 1997 - 2004 279 the Advances on Customers Accounts and section 7. 4 discuss the disclosure of the related parties transactions account. Then follows a discussion of the pictorial content in HSBC annual reports in section 7. 5. The structural change of the recruitment process of the HSBC is discussed in section 7. 6. Finally, a conclusion is drawn.
7. 1 Asian financial crisis 1997-1999
The Asian financial crisis started in mid-July after the handover of Hong Kong to
China. It was triggered by the financial collapse of the Thai baht and Thailand’s overextension in real estate prices (Agenor et al., 1999, Choi, 2000, Goldstein, 1998,
Hunter et al., 1999, Jao, 2001, Noble and Ravenhil, 2000, Zhang, 1998). The crisis spread into most of Southeast Asia, including Indonesia, Malaysia, South Korea, and the Philippines. The reasons for the crisis may have included the tendency of banks to incur excessive risks by overdependence upon short-term funds to finance long- term investments that were of doubtful viability, excessive lending which fuelled asset price inflation, ineffective banking supervision, and political interference
(Agenor et al., 1999, Choi, 2000, Hunter et al., 1999, Jao, 2001, Noble and
Ravenhil, 2000, Zhang, 1998).
The Asian financial crisis was an external disturbance for HSBC, as described by
Laughlin (1991). This external disturbance exerted pressure on the Hong Kong
Government and HKMA to adjust its policies. The organization had to respond to this external disturbance positively in order to survive. During the Asian financial crisis, Hong Kong was also hurt by the slump because its currency was pegged to the US dollar. The Hong Kong dollar was under speculative pressure and the
Chapter 7 Accounting in HSBC 1997 - 2004 280
HKMA had spent more than US$1 billion to defend the local currency. With US$80 billion in foreign reserves, the HKMA managed to maintain pegging with the US dollar. It also had purchased around US$15 billion worth of the component shares of the Hang Seng Index in mid-August 1998 as a strategy to ease the volatilities of the share market affected by speculators and prevent stock price adjustment (East
Asia Analytical Unit, 1999, Reyes, 1999, Yam, 1999a). In response to this external disturbance, the Government of Hong Kong became the largest shareholder of most of the 33 companies which made up the Hang Seng Index during the Asian financial crisis. It also owned almost 10% of HSBC’s shares (The Economist, 1998b). The government sold those shares in 2001. Jao (2001) commented that Hong Kong was the only economy that succeeded in defending its currency and the financial system against speculators. This success could be attributed to the government’s willingness to change its policy promptly in response to the attack by speculators on the share market in Hong Kong.
Gross Domestic Product registered a negative year of growth, falling 2.8% in 1998.
The Hang Seng Index stock prices had fallen more than 60% off the peak reached on
7th August 1997 to 6,660 (Jao, 2001). Although banks in Hong Kong had suffered reduced profitability during 1998, they were still profitable. The Financial Times
(1998) commented at that time that banks had the fundamental capital strength to manage their way through difficulties even in the event of rising bad debts and shrinking profits because they were highly capitalized and had high liquidity ratios.
Unlike other Asian countries, Hong Kong had a sound regulatory infrastructure, strong and well-capitalized banks, and disclosure standards comparable to the best in the world (Yam, 1999b). However, the financial crisis highlighted problems in risk
Chapter 7 Accounting in HSBC 1997 - 2004 281 management in the banking sector in Hong Kong, such as too much reliance on asset-based lending and the need for effective credit risk management. Therefore, in response to the external environment, HKMA revised the capital adequacy requirement and tightened the disclosure requirement in the banking sector. These aspects are further discussed in section 7.2.1.
I can see the impact of financial crisis through an analysis of financial measures during this period 1997-2004. Sections 7.2-7.5 explore HSBC’s responses to this crisis as demonstrated in their financial statements.
7. 2 Performance ratios
Financial reports are artefacts and outputs of the decision making of the bank. They do not provide a complete picture of the bank’s activities and condition (Gerald et al., 2003, Revsine et al., 2005). Management discretion in selecting from different acceptable accounting practices can cloud financial statement. Analysis of financial ratios is therefore useful for gathering information behind the numbers and also allows researchers to compare the performances of the bank’s activity, liquidity, profitability and solvency. The capital adequacy ratio, liquidity ratio, return on average shareholders’ funds, net interest margin, and profit on ordinary activities after tax are key performance indicators of the banking sector (Koch and
MacDonald, 2006).
7.2.1 Capital adequacy ratio
As mentioned in section 6.2.3, the capital adequacy requirement is a mandatory financial reporting requirement imposed by HKMA on all banks. It is used as a tool
Chapter 7 Accounting in HSBC 1997 - 2004 282 for the bank to manage credit risks, market risk and other associated risks. HKMA continued to adhere closely to international regulatory standards and revised the capital adequacy regime in 1997 to incorporate market risks based on the Basel
Committee’s84 1996 Amendment. HKMA is the supervisor of HSBC on a consolidated basis. It sets minimum capital requirements for banks and receives regular returns on capital adequacy. In 1997, it laid down additional capital requirements to cover market risks85 of trading positions (Yam, 2003a, 2003b,
2004). HKMA required the bank to hold additional capital to cover foreign exchange, interest rate, and equity risks. Throughout the year, HSBC met the minimum capital requirement set by HKMA.
From 1997 onwards, the bank disclosed the capital adequacy ratio according to the
HKMA requirement (taking into account market risk) as well as according to the
Third Schedule of the Banking Ordinance. This can be explained in institutional theory in terms of coercive influences, which suggests that an organization has to respond positively to changes in government policies in order to survive in the long run. The change in capital adequacy requirement served as an external disturbance
(Laughlin, 1991) for HSBC. This coercive influence exerted pressure on HSBC to conform to public expectations and demands. In order to survive and prove its legitimacy, HSBC had to comply with the externally dictated conditions. For example, the bank explained in the annual report that there was an increase of Tier
84 Details in Section 6.2.3. 85 Market risk is the risk incurred in the trading of assets and liabilities due to changes in interest rates, exchange rates and other asset prices. It is the incremental risk incurred by the bank when interest rate, foreign exchange and equity return risks are combined with an active trading strategy, especially if it involves short trading horizons.
Chapter 7 Accounting in HSBC 1997 - 2004 283
186 capital in 1997, due to profit retention. Tier 287 capital increased in 1997 due to the increased general provisions and new term preference shares issued to HSBC
Holdings, the immediate holding company, partly offset by reductions in property revaluation reserves and latent reserves on investment equity securities (The
Hongkong and Shanghai Banking Corporation Limited, 1998). The bank also had a detailed explanation on the percentage allowed by the HKMA on revaluation of property in Tier 2 capital.
According to Carse (1999), bank capital adequacy ratios average 18%, and no bank’s capital adequacy is less than 13%. However, after the serious domestic recession in 199888 in Hong Kong, the banking sector was subjected to major reform. HSBC’s capital adequacy ratio started to drop from 14.6% in 1998 to
11.9% in 2004 (refer to Figure 7-1). The related authorities strengthened prudential supervision in response to the crisis by increasing banks’ mandatory capital adequacy ratios to 10%, introducing a standing for interest recognition on non- performing loans (NPLs), and requiring local and foreign banks to disclose information on their NPLs89. The authorities developed a more formal risk-based supervisory system and improved disclosure requirements. For example, foreign
86 Tier 1 capital is linked to a bank’s book value of equity reflecting the concept of the core capital contributions of a bank’s owners. It includes paid-up ordinary shares, non-repayable share premium account, general reserves, retained earnings, minority interests in subsidiaries, and non-cumulative irredeemable preference shares. 87 Tier 2 capital is the secondary capital resources of a bank. It includes general provisions for doubtful debts, asset revaluation reserves, perpetual subordinated debt and loan-loss provisions. 88 Non-performing loans increased to an average 9% of outstanding loan by the end of March 1999. This was due to the exposure of authorized institutions in Hong Kong to enterprises in Guangdong province totalling US$2.5 billion, and the domestic economy appeared to have bottomed by mid 1999. 89 Banks must stop accruing interest on uncollateralized NPLs after three months and all loans overdue for more than a year.
Chapter 7 Accounting in HSBC 1997 - 2004 284 banks were required to publish information on their Hong Kong activities (Carse,
1999).
Oliver suggested that organizations ‘respond to institutional pressures that affect them’ (Oliver, 1991, 145) by employing acquiescence, compromise, avoidance, defiance and manipulative strategies. HSBC responded to institutional pressures by avoiding the necessity to conform. It only disclosed the minimum requirement of reporting in order to conceal its nonconformity, because ‘the appearance rather than conformity is often presumed to be sufficient for the attainment of legitimacy’
(Oliver, 1991, 155). HSBC explained the reasons for the drop of the capital adequacy ratio in various years. These reasons included an increase in advances to customers, and a decrease in property revaluation reserves. However, the bank stopped explaining the reason for the continuous decrease in the capital adequacy, which fell below 12%. There was also a trend of increasing Tier 1 capital from 2001 onwards (refer to Figure 7-1). This indicated that the bank had reduced its reserves on property and investment revaluation, and subordinated debt and general provisions. The bank did not provide any explanation for these changes. Although the average capital adequacy ratio of the bank was lower than other banks in Hong
Kong, it was far in excess of the 8% minimum recommended by the Basel
Committee as an international benchmark.
Chapter 7 Accounting in HSBC 1997 - 2004 285
Figure 7-1 Capital adequacy ratio for HSBC for 1989 -2004
Capital adequacy ratios
18 16 14 12 Total capital/risk- 10 weighted assets (%) 8 Tier 1 capital/risk- 6 weighted assets (%) 4
PRECENTAGE (%) PRECENTAGE 2 0 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 YEAR
Moreover, the bank disclosed a comprehensive table about the composition of Tier 1 and Tier 2 capital. For example, Tier 1 included the shareholders’ funds, minority interest; Tier 2 included the property revaluation reserves, long-term equity investments revaluation reserve, general provisions, and latent reserves. However, the bank did not disclose the breakdown of risk-weighted assets. Only the total amount of the risked-weighted assets was presented in the financial review (The
Hongkong and Shanghai Banking Corporation Limited, 1998, 1999, 2000, 2001,
2002, 2003, 2004).
The Basel Committee in 2004 further revised the framework of capital adequacy to adopt a more risk-sensitive approach to capital regulation. HKMA continued to follow the Basel time-table for implementing the revised framework. Financial institutions are expected to have their own choice of approaches. However, the
Banking (Amendment) Ordinance 2005 which was passed by the Legislative
Council in 2005 provided HKMA with the power to issue Capital Rules to set out the methods for calculating the capital adequacy ratio and disclosure standards according to the Basel requirements.
Chapter 7 Accounting in HSBC 1997 - 2004 286
7.2.2 Liquidity ratio
The liquidity ratio is important for measuring the ability of a bank to meet its obligations as they fall due. It also measures the relationship of a bank’s liquidity needs to meet deposit outflows and loan increases versus its actual or potential sources of liquidity from either selling an asset it holds or acquiring additional liabilities (Hempel et al., 1999). A larger liquidity ratio indicates a less risky bank but at the same time also less profitable because the bank has to sacrifice a greater profitability of long-term securities for the liquidity needs. All banks operating in
Hong Kong are required to maintain a minimum liquidity ratio of 25% calculated in accordance with the provisions of the Fourth Schedule of the Banking Ordinance
Section 102. Because this requirement applied separately to the Hong Kong branches of the Bank and to those subsidiary companies, the bank only disclosed the minimum requirement in the annual report. It did not disclose the liquidity ratio as a whole entity. The operation in Hong Kong generally performed better than its other subsidiaries around the world. Therefore this liquidity ratio may not reflect the actual liquidity of the bank as a group. As shown in Figure 7–2, the bank maintained its liquidity ratio well above 30% and reached 54.1% in 2001. This might have been a strategy of bank to boost its liquidity ratio in order to achieve legitimacy. HSBC admitted that a significant part of the bank’s overall funding came from current accounts and savings deposits payable on demand. Therefore, it was very important for HSBC to project an image of trust and maintain depositors’ confidence in the bank’s capital strength. HSBC even provided a one-page list of strategies for managing their liquidity ratio in the annual report between 1997 and
Chapter 7 Accounting in HSBC 1997 - 2004 287
2004 (The Hongkong and Shanghai Banking Corporation Limited 1998, 1999, 2000,
2001, 2002, 2003, 2004).
Figure 7-2 Liquidity ratio 1997-2004
Liquidity ratio 1997 - 2004
60.0 55.0 50.0 45.0 40.0 35.0 30.0
Percentage% 25.0 20.0 15.0 1997 1998 1999 2000 2001 2002 2003 2004 Year
7.2.3 Return on average shareholders’ funds
There was a trend for all banks to adopt innovative performance measures such as economic profit90 (economic value added) in 1998 (Kimball, 1998). This kind of measurement system for a bank’s performance could offer great benefits in terms of improved risk management, and greater efficiency in the use of capital (Kimball,
1998). This mimetic force pushed HSBC to implement a new strategy, ‘Managing for value’, in 1998 (The Hongkong and Shanghai Banking Corporation Limited,
1999, 2). The bank provided the ratio of the return on average shareholders’ funds on the first page of the bank’s financial highlight in 1998. This ratio measured the return earned by management on the funds contributed by ordinary shareholders.
According to the Chairman’s statement, “all businesses are now judged on targets set by the criteria of economic profit. This process assesses the cost of capital,
90 Economic profit is different from accounting profit. It is the difference between the revenue and the opportunity cost of the inputs used. This is also equivalent to "economic value added" (EVA).
Chapter 7 Accounting in HSBC 1997 - 2004 288 including the cost of equity capital, committed to a particular business activity and then sets a target return – a measure of economic profit – that the business has to achieve” (The Hongkong and Shanghai Banking Corporation Limited, 1999, 2).
This “economic profit” was not a requirement by any of the regulatory bodies.
However, the chairman claimed that this could ensure optimal efficiency in the allocation of capital and provide better returns and more efficient services for shareholders and customers (The Hongkong and Shanghai Banking Corporation
Limited, 1999). This measure required managers to include the opportunity cost of equity capital contributed by the shareholders of the firm when making investment and operating decisions. This means that units of equity capital would only be added until the marginal contribution of capital is equal to its opportunity cost, and the average return to equity capital will equal or exceed its opportunity cost (The
Hongkong and Shanghai Banking Corporation Limited, 1999). The traditional way of evaluating the banks’ performance only on the rate of growth of their reported profits did not take into account differences in the banks’ use of equity, and shareholders may have different required rates of return on different levels of risk of the equity invested (Gerald et al., 2003, Kimball, 1998).
The calculation of the cost of equity allocated to each individual project is a complicated process. The bank prepared the ratio of average return on shareholders’ funds as additional information, besides the required disclosure requirement, to assure its shareholders that HSBC was functioning not only profitably, but also efficiently with every dollar they invested. The theory as it stands is deficient
Chapter 7 Accounting in HSBC 1997 - 2004 289 because it does not adequately explain this circumstance. Institutional theory presumes that an organization responds passively towards the change.
There was a dramatic drop in 1998 (refer to Figure 7-3) which was due to the Asian financial crisis and this was consistent with other banks in Hong Kong. Unlike the previous annual reports before 1997, the bank only showed the actual figures of the return on average shareholders’ fund in 1998 compared with the 1997 figure. The bank continued to produce diagrams showing the return on average shareholders’ funds only after it resumed positive profit growth which reflected the gradual improvement in the economy in 1999. It is speculated that the bank was trying to hide the drop in its profitability in 1998 by not producing the graphic presentation.
HSBC used graphics in its annual report very strategically. “[A]nnual reports are a visual medium through which corporations, […] attempt to represent and constitute themselves” (Preston et al., 1996, 115). Financial graphics within annual reports, either using or not using graphs, play an important role in determining the perception of the corporation and in the interpretation of its financial health (Beattie and Jones, 1992, 1998, Penrose, 2008). Beattie and Jones (2008) commented that the perception of the data in a graph can be manipulated by the preparers of the annual reports through selection of graph type, colour, scale, emphasis, size and other treatments. The management of the HSBC sought to project a favourable image to the company through the selective use of graphs in 1998.
Chapter 7 Accounting in HSBC 1997 - 2004 290
Figure 7-3 Return on average shareholders’ funds
Return on Average Shareholders' Funds
35 30 25 20 15 10 Percentage (%) 5 0 1997 1998 1999 2000 2001 2002 2003 2004 Year
7.2.4 Net interest margin
The net interest margin measures the difference between the interest paid for deposits and borrowings, and the interest earned on loans and investments (Rose,
2002, Shanmugam et al., 1992). It is an important measure to the bank because it accounts for more than 70% of total revenue (The Hongkong and Shanghai Banking
Corporation Limited, 1998, 1999, 2000, 2001, 2002, 2003, 2004, 2005). A small change in margin has a huge impact on the profitability of a bank. The higher the margin, the more profit the bank made. The main sources of revenue are loans, investments and service fees.
The net interest margin of HSBC was very steady between 2 – 2.75%, as shown in
Figure 7-4, during 1997-2004. Although the margin was decreasing gradually from
2002, from around 2.5% to just below 2%, HSBC outperformed the banking sector in Hong Kong. The average net interest margin in the banking sector was between
1.65% and 2.01 during 1997-2004. The decline of interest margin in 1998 was due to the disturbance of the Asian financial crisis and the subsequent falls in the
Chapter 7 Accounting in HSBC 1997 - 2004 291 property price. The decline of interest margin from 2002-2004 reflected weak loan demand associated with high unemployment and persistent declines in property prices and intense competition in the mortgage market (Hong Kong Monetary
Authority 2003, 2004b). The reduction in bank lending spreads was due to the interest competition. HSBC managed to offset such adverse effects on profitability by boosting non-interest income (Hall et al., 2008).
Figure 7-4 Comparison of net interest margin 1997-2004
Comparison of Net Interest Margin 1997 - 2004
3
2.5 HSBC 2
1.5 Average in
Percentage (%) Percentage Banking 1 Sector 1997 1998 1999 2000 2001 2002 2003 2004 Year
Figure 7-5 Other Operating Income 1998 - 2004
Other Operating income Other Dealing profits Fees and commissions 35000
30000
25000
20000
15000 HK$ million HK$ 10000
5000
0 1998 1999 2000 2001 2002 2003 2004 Year
Chapter 7 Accounting in HSBC 1997 - 2004 292
7. 3 Advances to customers
A report done by Deloitte Touche Tohmatsu commented that HSBC was cited as providing the most comprehensive levels of disclosure, particularly in the areas of credit exposures and risk management in 1998 (Cheung, 1999). The bank also provided a comprehensive review of advances to customers and provisions against advances to customers. HSBC provided five to six pages about its credit and risk management from 1997 to 2004 in the Financial Review section of its annual reports.
In the annual reports’ notes on account from 1997 to 2004, HSBC disclosed two different sets of analysis of “Advances to Customers” account. One was based on categories used by the HSBC Group to manage associated risks. The other was a separate section containing an analysis of advances to customers by industry sectors, based on categories and definitions of categories contained in the “Quarterly
Analysis of Loans and Advances and Provisions” return that is required to be submitted to the Monetary Authority (refer to Figure 7-6 and Figure 7-7). The bank in this case adopted institutionally acceptable practices by disclosing the analysis on advances to customers according to the HKMA. Although this analysis might not enhance the efficiency of HSBC’s operations, presenting this information gave an acceptable public image, which was important if they were to survive. This action was described by Meyer and Rowan (1977) as decoupling. To avoid possible loss of legitimacy through inspections and evaluations, HSBC had to conform to the disclosure requirement set by HKMA. At the same time, the bank wanted to build a gap between their formal structures and actual work activities for how they managed their credit risk. The presentation of the analysis according to the HKMA was just
Chapter 7 Accounting in HSBC 1997 - 2004 293 the “presentation of organizational-self” rather than how they actually used this analysis to manage associated risks such as credit risk and liquidity risk (Carruthers,
1995, 315). They showed compliance with generally acceptable accounting standards while not affecting the actual way of work.
Figure 7-6 Advances to customer according to HSBC (abstract from HSBC Annual Report 2004, p.32)
Chapter 7 Accounting in HSBC 1997 - 2004 294
Figure 7-7 Advances to customers according to HKMA (abstract from HSBC Annual Report, 1997, p.33)
There is a general assumption that HKMA, as a Hong Kong Government regulatory agency, must act in the public interest (Levine and Forrence, 1990, Stigler, 1971).
The rhetoric of HSBC is that it is the “local bank” that acts in the public interest.
From the illustrations above, they said one thing but their documents show another.
They had to conform to HKMA’s regulatory requirement of reporting but they also wished to present a second set of numbers to a different group of audiences.
Government expectations, in terms of reporting and disclosure requirements in financial reports, can be identified as coercive institutional elements. This put pressure on HSBC to adopt “rational” accounting and management practices which were more likely to be rewarded. The analysis was prepared according to HKMA.
Chapter 7 Accounting in HSBC 1997 - 2004 295
It is suggested that the second set of analysis provided a better legitimizing tool for them. HSBC also constructed another reality.
The bank in its annual reports (1997-2004) divided the advances into nine different categories: “Residential mortgages”, “Other lending to individuals”, “Commercial real estate”, “Other property related lending”, “Commercial and industrial”,
“International trade”, “Non-bank financial institutions”, “Transport”, and “Others”
(refer to Figure 7-6). Contrary to this, HKMA required banks to categorize the loans and advances by industry sectors. HKMA claimed that it would have a better understanding of individual institutions’ exposure to different industry sectors
(Hong Kong Monetary Authority, 2000b). These categories included “Property development”, “Property investment”, “Financial concerns”, “Stockbrokers, wholesale and retail trade”, “Manufacturing”, and “Transport and transport equipment” (refer to Figure 7-7). HKMA suggested that the cause of bank failures might be imprudent lending or a downturn in the economy. Therefore, asset quality and adequacy of provisions were major areas for them to pay attention to as the banking supervisors (Hong Kong Monetary Authority, 1994). They also explained that various banking regulatory bodies in other countries such as Singapore,
Malaysia, Korea and Australia had adopted some form of loan classification system.
These systems were mostly modelled after the system adopted by the supervisory authorities of the US. This is the institutional force identified by DiMaggio and
Powell (1983), which influenced HKMA to tailor its policies and practices in accordance with the circumstances currently prevailing in the banking industry.
HKMA did not want to stand out as being different, so it behaved in ways that were socially acceptable globally. Therefore, HKMA concluded that Hong Kong should
Chapter 7 Accounting in HSBC 1997 - 2004 296 have a similar system to be in line with internationally accepted practices and modelled after internationally accepted practices.
There were some significant differences between the definitions of categories of advances used by HKMA and the bank. For example, the definition of “Property lending”. HSBC explained in the Financial Review section of the annual report that they adopted a wider definition of “Property lending” and they included advances to non-property companies for the purchase of properties for use in their own businesses in “Other property related lending” and “Advances relating to infrastructure projects in commercial real estate” (The Hongkong and Shanghai
Banking Corporation Limited, 1998, 1999, 2000, 2001, 2002, 2003, 2004, 2005).
However, these advances were classified differently from those of the HKMA and included in various other categories. HSBC had to show compliance with norms demanded by HKMA but this adoption of institutionally acceptable practices might not enhance the efficiency of its operations. Therefore, HKBC chose to decouple from the coercive pressure. These decoupling accounting practices were also shown in its definitions of market sectors.
The definitions of market sectors by HSBC, particularly in “Non-bank financial institutions” and “international trade”, were classified different from those of
HKMA. Lending to “non-bank financial institutions” included lending by HSBC to financial holding companies. However, these were included in “Others” in the
HKMA analysis guideline. For the “International trade” category, the bank also adopted a wider definition and included lending in respect of import and export companies and lending to other companies specifically to finance international trade.
Chapter 7 Accounting in HSBC 1997 - 2004 297
However, according to the HKMA analysis guide, such lending was to be included in the “Wholesale and retail trade” and the “Others” sectors.
As lending is a major operating activity of the bank, HSBC emphasized in their annual report that they took a conservative approach to the provisions against advances to customers. Non-performing advances classified by the bank included advances to customers which were overdue for more than three months. These non- performing advances included advances which were not yet more than three months overdue but which were considered by management to be doubtful as to full recovery of principal or interest for other reasons. Another example is that if one advance to a particular customer was classified as non-performing, all other advances to the same customer were classified as non-performing (The Hongkong and Shanghai Banking Corporation Limited, 1997, 1998, 1999, 2000, 2001, 2002,
2003, 2004). HSBC used a detailed explanation of the breakdown of advances to customers’ accounts as a tool to achieve legitimacy and project an image of higher accountability to the public.
The bank also included a summary of other major differences between total advances to customers as reported in the HKMA returns and in the notes of accounts. For example, advances to non-banking subsidiary and subsidiary companies were included in advances to customers in the HKMA returns but these were disclosed separately in the bank’s own analysis. “Interest in suspense” was required to be deducted from advances to customers in the HKMA returns but was disclosed separately in the analysis by the bank. The HKMA returns only included branches of the bank and banking subsidiary companies and did not include
Chapter 7 Accounting in HSBC 1997 - 2004 298 settlement accounts with non-banks. The HKMA returns only included import bills receivable and excluded other categories of trade bills (the Hongkong and Shanghai
Banking Corporation Limited, 1998, 1999, 2000, 2001, 2002, 2003, 2004). The bank also included a geographical analysis which was classified by the location of the branch responsible for advancing the funds. This analysis was not required by the HKMA.
The total amounts of “Advances to Customers” shown on the consolidated balance sheet were reconciled with the analysis based on categories used by the bank.
Because of different interpretations of some accounts, there was a slight difference between the figures produced by using the analysis based on the HKMA recommendations, and those of the bank. As shown in Figure 7-8, the amounts produced under the bank’s definition of loans and advances were less than under the
HKMA analysis. The reasons for the differences may due to the explanations given above. Although the HKMA required the bank to submit the analysis quarterly, there was no requirement on the actual amount presented in the annual reports.
HSBC chose the lower value for “Advances to customers” perhaps because of the capital adequacy requirement. An increase in the risk-weighted asset would decrease the capital adequacy ratio. Therefore, in order to achieve a higher capital adequacy ratio, the bank would choose a lower value of advances to customers to project a healthier financial image in public. HSBC also provided geographical information classified by the location of principal operations of the subsidiary company by the location of the branch responsible for advancing funds for internal purposes. In this case, not only could HSBC avoid further inspection because of their compliance to the reporting requirements, but HKMA would “accept
Chapter 7 Accounting in HSBC 1997 - 2004 299 ceremonially at face value the credentials, ambiguous goals, and categorical evaluations that are characteristic of ceremonial organizations” (Meyer and Rowan,
1977, 359).
Figure 7-8 Comparison of Advances to Customers 1997-2004
Advances to Customers 1997 - 2004
2000000 1800000 1600000
1400000 1200000 HKMA 1000000 HSBC HK$m 800000 600000 400000 200000 0 1997 1998 1999 2000 2001 2002 2003 2004 Year
HKMA has the legislative authority over HSBC. HSBC has to comply with the provisions of the Banking Ordinance which require it to maintain adequate liquidity and capital adequacy and submit periodic returns to the HKMA on the required financial information. HKMA also has power to collect prudential data on both routine and ah hoc basis. However, HSBC provided non-mandatory information in their reports and a constructed reality for the audiences of its annual reports.
Institutional theory could not provide an explanation for the power struggle between the HKMA and HSBC.
Chapter 7 Accounting in HSBC 1997 - 2004 300
7. 4 Related party transactions
During 2003, nearly two-thirds of HK accounting standards changed. There were very substantive changes in recognition and measurement principles, new disclosures, and elimination of accounting policy choices other than just reformatting into the new numbering system (Deloitte Touche Tohmatsu, 2004).
With the pressure of globalization and matching accounting standards which were acceptable internationally, the Financial Accounting Standards Committee of the then Hong Kong Institute of Certified Public Accountants (HKICPA) decided to base Hong Kong accounting standards on International Financial Reporting
Standards promulgated by the International Accounting Standards Board (IASB).
HKICPA was trying to model international financial reporting standards which were perceived to be more legitimate. One of the updated Hong Kong Standards includes
“Related Party Disclosures”.
IAS 24 (Related Party Disclosures) and HK SSAP 20 (Related Party Disclosures) are consistent with each other, except that parties subject to common joint control or common significant influence are not regarded as related parties under IAS 24, but are specifically included in the SSAP 20 definition. IAS 24 requires the disclosure of related party relationships where control exists, irrespective of whether or not there have been transactions between the related parties, whereas SSAP 20 does not require any disclosures in the absence of transactions. IAS 24 exempts from disclosure transactions between other state-controlled enterprises, an exemption which is not reflected in SSAP 20 (Hong Kong Institute of Certified
Public Accountants, 2004). Since HSBC has a number of related parties all over the
Chapter 7 Accounting in HSBC 1997 - 2004 301 world, this exemption in disclosure could help the bank in concealing the relationship between the bank and other parties.
HSBC prepared its financial statements in accordance with all Hong Kong Financial
Reporting Standards (which include all applicable Statements of Standard
Accounting Practices and Interpretations) issued by the Hong Kong Society of
Accountants, the provisions of the Hong Kong Companies Ordinance and accounting principles generally accepted in Hong Kong. Therefore it is suspected that the bank may have taken advantage of the accounting standards which were more suitable for the bank. Although the bank followed most of the international accounting standard during the period 1997-2004, the bank might have taken advantage of the exemption available under the Hong Kong Statement of Standard
Accounting Practice 20 on ‘Related Party Disclosures’ (HKSSAP 20) for wholly owned subsidiaries not to disclose related party transactions in 2003. The bank claimed that their consolidated accounts contained related party disclosures which were comparable to those required by HK SSAP 20 (The Hongkong and Shanghai
Banking Corporation Limited, 2004, 99).
7. 5 Pictorial content in HSBC annual reports
Pictorial content in the annual reports of HSBC provided users with another way of understanding organizational changes. The 1997 handover of Hong Kong has occasionally been the theme of HSBC’s annual report since 1994. For example, the cover paper of the 1984 annual report was a girl who would celebrate her 21st birthday in 1997. The bank purposely used a Chinese girl on the cover page to represent a change of culture in 1994 (refer to section 6.3.2). It also started to issue
Chapter 7 Accounting in HSBC 1997 - 2004 302 both English and Chinese versions of the ordinary yearly general meeting and statement to shareholders by the Chairman, MGR Sandery, in 1997. The bank commented that political and economic factors would affect the bank’s success. It viewed the Sino-British agreement as a “great boost to business prospects” (The
Hongkong and Shanghai Banking Corporation Limited, 1998, 2). Apart from the image of the cover page of the annual report, the bank also introduced a new series of Hong Kong banknotes. This clearly demonstrated the connection with China.
In the 1993 annual report, the bank commented about the future of Hong Kong, stating that “confidence has subsequently been boosted by progress in the discussions between the UK and China on the constitutional future of Hong Kong.
This sentiment rests on the general expectation that the final form of the agreement will embody assured recognition of Hong Kong’s distinctive needs.” It also supported the freedom of Hong Kong. This was reflected by the comment by a
Chairman of HSBC stating that “Hong Kong’s people have and must retain the freedom of spirit to be innovative, rather than derivative; to be at liberty to seek fulfilment of all aspects of their lives through priorities of their own making and not according to priorities composed by authority” (The Hongkong and Shanghai
Banking Corporation Limited, 1994, 5).
One year before the handover, the theme of the cover in 1996 was “Hong Kong’s future lies in its status as a SAR of the People’s Republic of China”. The bank once again emphasized that
“detailed constitutional arrangements guarantee the territory a high
degree of autonomy and will preserve its thriving marking economy.
Chapter 7 Accounting in HSBC 1997 - 2004 303
At the same time, HK owes much of its success to its growing
interdependence with the Mainland. The process of integration is
reflected in mutual trade and investment, in the development of
transport and tourist infrastructure, in the distribution of supplies
and utilities, in the broadening of technology links, in the growth of
the consumer market, and in an increasing number of cultural,
academic, social welfare and artistic exchanges” (The Hongkong
and Shanghai Banking Corporation Limited, 1997a, 4).
Therefore, it would be reasonable for the public to expect that HSBC’s 1997 annual report would carry on the theme of the handover of Hong Kong. However, the cover of the annual report in 1997 was a simple and clear design in red with “1997” on the cover in small print (refer to Figure 7-9). The bank may have wanted to remove its
British image to the general public. It is also interesting to see that the annual review of the bank in 1997 was in black and white, including the photos and pictures in the report. Only its logo and some headings and lines were in red. HSBC gave a very low profile to the sensitive issue of “1997”. This strategy was very different from the bank’s previous annual report style.
Chapter 7 Accounting in HSBC 1997 - 2004 304
Figure 7-9 HSBC Annual Report 1997-2000
Chapter 7 Accounting in HSBC 1997 - 2004 305
Figure 7-10 HSBC Annual Report 2000-20044
Chapter 7 Accounting in HSBC 1997 - 2004 306
From 1997 onwards, the covers of HSBC’s annual reports were standardized without any pictures on them (refer to Figure 7-10). It is suspected that HSBC tried to conceal its British history by presenting a simple design for the covers of the annual reports. The bank also officially changed its corporate logo and local name in 1998 to develop a global brand – HSBC. A local newspaper commented on the new brand “HSBC: the letters symbolise state-of-the-art financial market efficiency, electronic screens and whizzkid brokers- the world of initials and acronyms with no time for traditional nomenclature” (South China Morning Post, 1998, 1). Banks seek to inspire confidence and loyalty among their customers and legitimize themselves as a local bank. HSBC launched a worldwide campaign called “Global
Images” to promote the new brand name to new and existing customers. Some people criticized it as a bad move from a public relations perspective (Bridge, 1999,
Schloss and Cheung, 1998). However, its Chinese name, Wayfoong, remained the same. The pictures shown in the annual report in 1997 and 1998 also contained a lot of Asian employees working hard to serve customers. This change of employee structure will be further discussed in the next section.
7. 6 Structural change
The bank started to have its entrance test conducted in both English and Chinese in
1995. The bank always conducts the entrance test for management levels in
English. According to an anonymous senior manager of the bank [refer to Appendix
1], there is no need to use Chinese in the bank at all. The first language of almost all of the senior managers is English and they have graduated from Britain or the USA.
It is a tradition of the bank to recruit senior managers from its International
Management programme. In the past, these international managers were responsible
Chapter 7 Accounting in HSBC 1997 - 2004 307 for regional personal financial services, commercial banking, corporate, investment banking and markets. They were all British in the past and first trained in London and then relocated in different countries. However, this tradition changed after
1997.
As mentioned in the 1998 annual report, the bank announced the group’s new branding. All businesses of the bank were drawn together under the HSBC name to create a single unified global brand. They wanted to project a single, hexagon sign,
“symbols of the reach and strength” of the bank (The Hongkong and Shanghai
Banking Corporation Limited, 1999, 2). According to interviewee 1, there was political struggle within the bank. As more and more business related to China, creating the need for the Chinese language for communication, the English language was no longer sufficient to cover international operational needs. One of the essential criteria was therefore to be able to operate in the two languages. This trend saw the creation of a local recruitment program. As mentioned in Section 6.3.2, the bank had its first Chinese general manager in 1995. This led the way to having a local employee working as an international manager. There was a need to recruit from local staff who had experience in a specific area. For example, the first
Chinese general manger was from the Chase Manhattan Bank, and others were from
Morgan Stanley. These Asian experts from other financial organizations established themselves in HSBC as the main constituents of the banking industry. They have internalized and established socially acceptable norms and values for the industry.
As a result, HSBC’s changed recruiting policy was a response to the normative force described by DiMaggio and Powell (1993). According to both interviewee 1 and
Mr. Cheng, Chairman of HSBC, the number of British employees in Hong Kong has
Chapter 7 Accounting in HSBC 1997 - 2004 308 also decreased since 1997. The managers in Hong Kong no longer reported to the international managers but the Group Manager. Interviewee 1 commented that this change was mainly due to globalization and competitiveness and not the 1997 issue.
During the informal interview, the interviewee repeatedly mentioned
“globalization”, which is consistent with the ideology of the bank. It was suspected that interviewee 1 was using the rhetoric of the bank, “World local bank”, which was embedded in the organization.
To sum up
In this chapter, HSBC’s annual reports between 1997 and 2004 were discussed. The change in the financial reporting of the bank was considered in light of institutional theory. It was argued that HSBC would be expected to achieve and maintain legitimacy if it could match its accounting practices to society’s cultural expectation.
For example, after the disturbance of the Asian financial crisis in 1997, the tightened disclosure requirements for the bank were reflected in the annual reports of HSBC, such as the capital adequacy ratio and liquidity ratio. Apart from conforming to the legal requirements, HSBC deliberately resisted institutional pressures to conform because of its own beliefs. The bank responded by decoupling from the norm. An example of this was the disclosure of the HKMA analysis on advances to customers as a ceremonial practice and their actual analysis based on their operations. The bank emphasized that it did not use it for its own operations. The handover of Hong
Kong to China also triggered the change in presentation of the annual report and its organizational structure. The cultural influence of the Chinese was reflected in the recruitment process of the bank from 1997 onwards. Isomorphic pressure pushed
HSBC to recruit staff with both a Western and an Eastern background.
Chapter 7 Accounting in HSBC 1997 - 2004 309
In chapter eight, conclusions regarding the research question will be addressed. The contributions of the research will be presented, followed by a discussion of the limitations of the research and opportunities for future research.
Chapter 8 Conclusion 310
CHAPTER 8 CONCLUSION
In chapter seven, the annual reports from 1997 to 2004 were discussed. In this chapter, conclusions about the research question will be made. The contributions of this research to methodology and theory will be presented. A discussion of the research limitations will be discussed, and the significance of the conclusions will be reinforced.
This is a unique story which considers what is expected of financial reporting in one particular organization of the banking industry in Hong Kong in a time of change and uncertainty. This organization is the HSBC Bank. HSBC is an organization well known to the world because of its high profile as the “world’s local bank”. It achieves that performance by means of its special identity as a Hong Kong based
British financial institution.
The financial reporting of an organization such as this has great significance to the public. The significance of HSBC in both social and economic terms was discussed and established in chapter one. Its founders, employees, the government, major regulators and professional bodies are all stakeholders in the future of HSBC. Since the bank is one of the note-issuing banks in Hong Kong and once its de facto central bank, as well as one of the largest financial institutions in the world, there is a call for accountability and a need for appropriate financial reporting. From the public accountability point of view, and given societal expectations, the manner in which a financial institution such as HSBC manages, and accounts to its shareholders and other stakeholders is likely to attract widespread attention.
Chapter 8 Conclusion 311
The historical development of HSBC was detailed in chapter four. The influence of the bank’s founder, Thomas Sutherland, has been profound and continues to this day. His institution of Scottish banking principles set the bank on a course and developed a culture through which organizational practices are assessed, often filtered through people’s interpretations of what the founder would have done.
HSBC was no longer a local bank for British traders. It has become one of the largest world financial institutions with vast assets, thousands of employees and a good reputation that has given it iconic status in the eyes of the world.
Organizations within the banking sector have to operate in a manner that is accountable to the public, as they adapt to changing regulations, political issues and societal attitudes. It is especially the case for those operated in Hong Kong, which has undergone significant change. HSBC, a Scottish/British bank, is operating in a changing political environment from the West to the East with challenging financial reporting requirements. In order to meet different expectations, HSBC has experienced a huge impact from the adoption of different accounting practices in order to meet the expectations of a public which has burst into its existing organizational structures: These changes provided the background which are subject of this study.
According to Laughlin (1987, 498), accounting systems are not merely “technical phenomena” but are social processes. Therefore, study of these systems would involve human interest. The analysis of financial statements was described in chapter five, six and seven. HSBC’s culture has a profound effect on the way the information is disclosed in its annual report.
Chapter 8 Conclusion 312
HSBC tried its best to build and maintain the image of a reliable bank, which was highlighted in chapter four. With the change of sovereignty from the East to the
West, the bank must necessarily project an image which will provide the legitimacy necessary to maintain its investors’ trust. Therefore the adoption of socially acceptable financial reporting is one manifestation of the desire to enhance the image.
Although HSBC was the de facto central bank in Hong Kong, its privileges with the
British government have been abolished since HSBC lost its power as the ultimate clearing bank, under the new accounting arrangements since the 1980s, and with the establishment of the Hong Kong Monetary Authority in 1997. Therefore, HSBC has to maintain its legitimacy through its financial reporting.
The findings of this study support the findings of Wong and Birnbaum-More (1994) who found that multinational banks operating in Hong Kong were under coercive influence from legal requirements. HSBC, as a listed company in both London and
Hong Kong, has to comply with all the legal requirements in Hong Kong and internationally.
This study is also in line with the studies of both Tse and Yip (2003) and Drake et al. (2006). They argued that HSBC dominated in Hong Kong during the 1980s.
Although HSBC had been affected by a range of external factors (macroeconomic and housing market factors) outside the control of the institution’s management, it could still maintain its legitimacy in Hong Kong.
Chapter 8 Conclusion 313
8. 1 From the perspective of institutional theory
To answer the question “what is expected of accounting in times of change and uncertainty”, this thesis mainly focused on the accounting practices adopted and changes of disclosure in the annual reports in response to the environmental disturbances identified in chapter four. In accordance with a central tenet of institutional theory, HSBC is embedded in the society in which it performs.
Therefore, it is necessary to consider both the micro view of the bank and the macro view of Hong Kong at the same time. This thesis has sought to consider both views, with its unique societal setting being described in detail. The micro view could show that the bank’s culture and structure have been influenced by the changes in accounting/financial requirements. The macro view could show that there is an increasing pressure from the Chinese Government towards the banking industry in
Hong Kong.
This thesis analysed the annual reports of HSBC in three phases. The first phase from 1967-1979 was presented in chapter five. HSBC faced disturbances which included the devaluation of sterling and the acquisition of a Chinese local bank. The second phase from 1980-1996 was presented in chapter six. This period indicated that the bank had to face the new challenges of the reversion of Hong Kong’s sovereignty to China and the confidence of the public in the bank. The third phase from 1997-2004 was discussed in chapter seven.
Applying institutional theory to HSBC’s annual reporting provides insights into the way changes occurred in the expectations and uses of financial reports. The institutional influences that sprang from society have been identified in previous
Chapter 8 Conclusion 314 chapters. Organizations in the banking industry are exceptionally vulnerable to influences from society and require the affirmation of society if they are to maintain legitimacy and have long-term survival.
HSBC operates in an environment where huge changes in institutional arrangements have occurred, particularly in relation to expected financial reporting and disclosure.
Annual reports appeared to be very much concerned with image promotion and the bank’s global operations. With the changes in society, HSBC had to adopt accounting practices and financial reporting that positively influenced investors’ perceptions about its stability and operations, and to maintain its legitimacy in the eyes of society. Institutional theory suggests that mimetic organizations are perceived to be more successful or legitimate when the environment is ambiguous and uncertain (Powell and DiMaggio, 1991). Mimetic isomorphism best explains why organizations adopt certain procedures and policies to achieve conformity with institutionalized rules and legitimacy in gaining society’s support. As discussed in chapter four, the founder of HSBC used Scottish banking principles when he established the bank in Hong Kong in 1865. At that early stage of the establishment of the bank, there was uncertainty in the society of Hong Kong. The bank therefore had to adopt banking principles that were successful in Britain and Scotland to assist in gaining the support of traders in Hong Kong.
Institutional theory also suggests that organizations conform to rules and regulations from formal and informal pressures. This is referred to as coercive isomorphism, which can explain the changes in organizations not only by following rules and regulation from authorities but also by conforming to what is generally expected by society (Oliver, 1997). The general public will give legitimacy to organizations that
Chapter 8 Conclusion 315 conform explicitly to regulations imposed by authorized organizations.
Organizations which continuously conform to coercive pressures over a period of time will get legitimizing authority in their field.
This study is consistent with Ang and Cummings’ (1997) findings that organizations need not passively conform to external disturbances. They argue that banks strategically respond to institutional influences and these institutional influences evoke different strategic responses from banks. It is evident that the observed patterns fully endorse the theoretical patterns in chapter five and six. For the period
1967-1979, during the time of disturbances such as the devaluation of sterling and the riots in China, HSBC’s financial reporting was changed and influenced by coercive forces. HSBC tightened its reporting requirement due to the disturbances.
The acquisition of MMBI affected the bank in connection with its operating requirement of its reporting requirement of disclosing its inner reserve, audit reports, revaluation of property and investment in subsidiaries, and its capital account. The bank had to project itself as a financially sound institution in order to survive.
During 1980-1996, Hong Kong was in the process of transferring its sovereignty to the Chinese Government. As discussed in chapter six, the bank’s financial reporting was once again changed to reflect the influence of both the coercive and mimetic forces of the disturbances. The bank not only closely conformed with the regulations, it also changed its internal structure. It started to work closely with the
Chinese Government and the influence of Chinese culture, as can been seen from the annual reports.
Chapter 8 Conclusion 316
Since 1997, the annual reports have been standardized. The disclosure practices appeared to be decoupled from the accounting standard required by HKMA, with disparities between the required disclosure of advances to customers and the additional disclosure and actual practice of the bank, as already highlighted. They appeared to be adopted as a result of normative institutional pressures. This thesis demonstrates that some significant events triggered the additional public disclosure in annual reports and public accountability in order for HSBC to legitimate itself to the new Hong Kong order and mainland Chinese expectations.
Figure 8-1 Summary of findings
Chapter 4 a The disturbances 1. Founder’s influence 2. Criticism of early financial reporting 3. Feng shui 4. Players around the organizations b Outcome of the disturbances 1. N/A in terms of external changes 2. Social expectation of society. (e.g. banking rules, law, 3. N/A political structures) 4. Companies Ordinance, Accounting professional body in Hong Kong, The Exchange Banks’ Association, Hong Kong Association of Banks, Bank Ordinance, and Stock Exchange requirements. c The effect of the 1. Scottish banking principle applied to disturbances (directly or HSBC. indirectly) on HSBC’s 2. HSBC disclosed the losses which swept accounting and financial away the Reserve Fund and prepare a set reporting practices of financial statements for inspection by the shareholders. 3. N/A 4. Explained in detail in Chapter 5-7. d HSBC’s reaction to 1. Scottish/British influence on the early disturbances reflects more accounting practices of HSBC. the impact of Chinese or 2. N/A British culture? 3. HSBC was influenced by the Chinese fung shui in the construction of the
Chapter 8 Conclusion 317
building and corporate culture. 4. Explained in detail in Chapter 5-7
e How the effect is 1. Mimetic influence from the founder. understood with an IT 2. Under the pressures of society, HSBC had framework to conform with the public expectation about its financial reporting. 3. Mimetic influence from the belief of the Chinese. 4. Institutional Theory helps to understand the way HSBC responds to institutional pressures for conformity. f IT breaks down and needs to 1. N/A be supplemented by MRT 2. N/A 3. the imprints of culture could not be explain simply by Institutional Theory. 4. N/A Chapter 5 a The disturbances 1. Acquisition of Heng Sang Bank before 1967. 2. Devaluation of sterling in 1967. 3. Acquisition of Marine Midland Banks Incorporated (MMBI) in 1979. b Outcome of the disturbances 1. Banking Ordinance amended in 1967 in terms of external changes 2. Banks suffered loss due to the (e.g. banking rules, law, devaluation of sterling against the US political structures) dollar because they were required to hold sterling for reserves. 3. HSBC has to comply with the GAAP of the Americans because of the acquisition. c The effect of the 1. Disclosure of liquidity ratio and capital disturbances (directly or adequacy ratio, and increased loan and indirectly) on HSBC’s advances during the Red Guard period. accounting and financial 2. HSBC absorbed the loss on the reporting practices devaluation of sterling by drawing down from inner reserves. 3. The United States regulatory authorities showed concern about the bank’s reporting of the inner reserve. HSBC refused to disclose its inner reserve. HSBC listed in both UK and US. HSBC’s accounts had to be presented a
Chapter 8 Conclusion 318
published with explanations relative to the differences between the bank’s practices and GAAP. d HSBC’s reaction to 1. HSBC had increase loan at the cost of disturbances reflects more liquidity because it has to project a the impact of Chinese or secure image to public British culture 2. Non-disclosure of inner reserves account was a traditional British banking practice. 3. Non-disclosure of inner reserves account was a traditional British banking practice. e How the effect is understood 1. Coercive forces from changes in with an IT framework banking ordinance and accounting standards 2. Mimetic influences on HSBC to set up an exchange contingencies fund within its inner reserves. 3. coercive forces from stock listing regulations f IT breaks down and needs to 1. N/A be supplemented by MRT 2. HSBC participated in the Hong Kong Government’s financial consultation process of the devaluation of sterling. HSBC expressed its disagreement with the devaluation in the financial reports. 3. HSBC was supported by the Hong Kong Government for non-disclosure of its inner reserves account.
Chapter 6 a The disturbances 1. Restructure of HSBC in 1980 2. Banking crisis between 1982 and 1986. 3. 1997 confidence issue in 1984. 4. Stock market crash in 1987 5. New accounting arrangements in 1988. 6. Move to London in 1990. b Outcome of the disturbances 1. N/A in terms of external changes 2. A new Banking Ordinance to tighten the (e.g. banking rules, law, regulation of the banking sector. political structures) 3. The exchange system in Hong Kong changed from a freely floating rate to a
Chapter 8 Conclusion 319
linked exchange rate system in 1983. 4. The Government, BOC(HK), and HSBC organized in support of the guarantee corporation. 5. New accounting arrangements between the Hong Kong government’s Exchange Fund and the bank as the clearing house. 6. Incorporated under the Companies Ordinance instead of its own Ordinance. The Tiananmen Square protest and political instability in China. c The effect of the 1. HSBC emphasized their idea of disturbances (directly or globalisation through its design of its indirectly) on HSBC’s annual reports. accounting and financial 2. HSBC has to maintain at least 8% of the reporting practices capital base to their risk-weighted credit exposures. 3. HSBC later became the clearing bank of the US dollar. HSBC used the annual reports to express its confidence in the future of Hong Kong. 4. HSBC voluntarily provided HK$2 billion for the rescue plan. 5. HSBC has to maintain a Hong Kong dollar account with the Exchange Fund and keep the account’s balance equal to the net clearing balance in the local banking system. 6. HSBC emphasized their loyalty to Hong Kong in its annual report. d HSBC’s reaction to 1. The covers of HSBC’s annual reports disturbances reflects more reflect the influence of the Chinese the impact of Chinese or culture. British culture 2. HSBC strongly opposed the new regulation 3. Chinese culture influenced the cover of HSBC’s 1984 annual report. 4. HSBC’s status would be affected by its rival, BOC(HK), if it did not cooperate with the Hong Kong Government. 5. N/A 6. Increased political pressure from the Chinese Government forced HSBC to pledge its loyalty to Hong Kong. e How the effect is understood 1. Mimicking a successful multinational with an IT framework organization by changing its corporate
Chapter 8 Conclusion 320
identity could increase HSBC’s prestige, stability, and legitimacy. 2. Coercive pressure from both the local and international regulations to comply with the new standard. 3. N/A 4. Mimetic force to provide support to guarantee corporations. 5. New accounting arrangements. 6. A mimetic process of HSBC to restructure by creating a holding company and registered HSBC in London. f IT breaks down and needs to 1. MRT helps to explain the changes that be supplemented by MRT took place in HSBC’s financial reporting by incorporating the non- financial information such as an analysis of its pictures and graphs in the annual report. 2. N/A 3. MRT helps to explain the changes that took place in HSBC’s financial reporting by incorporating the non- financial information such as an analysis of its pictures and graphs in the annual report. 4. N/A 5. Institutional Theory could not explain the power loss of HSBC under the new accounting arrangements. 6. N/A Chapter 7 a The disturbances 1. Asian financial crisis 1997-1999 2. Hand over of Hong Kong to China b Outcome of the disturbances 1. Changed in capital adequacy and in terms of external changes liquidity requirements, HKMA (e.g. banking rules, law, requirements on disclosure of advances political structures) to customers account 2. N/A c The effect of the 1. HSBC complies with the provision of disturbances (directly or the Banking Ordinance to maintain indirectly) on HSBC’s adequate liquidity and capital adequacy. accounting and financial 2. Presentation of annual reports has reporting practices changed.
Chapter 8 Conclusion 321
d HSBC’s reaction to 1. N/A disturbances reflects more 2. Chinese culture influenced HSBC’s the impact of Chinese or organizational structure. For example, British culture the recruitment process, and employed a Chinese as the Chairman. e How the effect is understood 1. Coercive power of the HKMA and with an IT framework accounting professional. 2. HSBC decoupled from the required reporting requirements from HKMA and voluntarily disclosed additional information on the advances to customers account. f IT breaks down and needs to 1. MRT helps to bring out both qualitative be supplemented by MRT and quantitative evidence of HSBC’s reaction on issue of 1997. 2. Institutional Theory could not provide explanation for the power struggle between the HKMA and HSBC.
8. 2 Contributions
The contributions of the thesis are twofold. First, it theoretically develops links between Laughlin’s (1995) Middle Range Thinking (MRT) and Institutional theory
(Di Maggio and Powell, 1983). The approach adopted in this research provides an important contribution to existing methodologies and offers an innovative investigative framework for studies of the banking sector. Skeletal theory guides and facilitates the discourse necessary for analyses of the political, economic, and social influences on accounting and banking. Secondly, this thesis applies methodology and methods novel to research in banking to enable a contextual understanding of the Asia Pacific regulatory environments. Both qualitative and quantitative methods of investigation are employed. Because of the complexity of
Chapter 8 Conclusion 322 the situation of HSBC, an inter-subjective approach to theorising is necessary to interrogate historical and cultural impacts.
The theoretical approach developed in chapter three is also unique to banking studies. Institutional theory was consistent with the methodology of this research.
This theory is relatively unused in studies of the banking industry. Therefore, this research not only fills a theoretical void by considering the social factors in banking studies, it goes further by combining with Laughlin’s organizational disturbances to explain the change in the financial reporting of HSBC.
It provides a comprehensive framework for conducting an examination of the change of annual reports in the banking industry. The complementary nature of the methodology and theory developed in this research therefore provides a holistic research framework for investigations in the banking industry. This study also provides insightful information on how HSBC successfully adapted when facing external environmental disturbances.
8. 3 Limitations and recommendations for future research in the area
Future research in the area relates to the methods used to collect data to support the research question. Although publicly available information offered relatively unproblematic access, observation by the participant may add valuable insights to the research findings. The main barrier to participant observation would be gaining access to HSBC’s processes, especially given the sensitive nature of the research issues.
Chapter 8 Conclusion 323
Other aspects of the banking industry may also be explored using the methodology and theory developed in this research. The disclosure requirements of financial institutions are the major concerns and interest to many stakeholder groups such as government, investors, environmental groups and the general public.
The purpose of this thesis has been to critique the “one country, two systems” policy as it applies to the banking sector in Hong Kong. A framework has been developed, which captured the changes in the annual reports. It demonstrates that some significant events triggered additional public disclosure in annual reports and public accountability in order for HSBC to legitimate itself to the new Hong Kong order and Chinese expectations. This new approach is valuable in this banking study because it gives a different perspective on acquiring banking knowledge.
References 324
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Appendix 348
APPENDIX 1 TRANSCRIPTS OF UNSTRUCTURED INTERVIEWS
Appendix 352 APPENDIX 2 SUMMARIES OF THE DEVELOPMENT OF ACCOUNTING IN HONG KONG
1865 The first Companies Ordinance in 1865 was based on the UK Companies Act of 1862 and amendments in the UK company legislation were followed by corresponding changes in the HK statute.
Pre-1973 - heavily influenced by UK standards and practices. - 1932 company Ordinance was based on UK companies Act of 1929. - later versions of company ordinance incorporated provisions of UK 1948 Companies Act. - accounting profession in HK was regulated by the government’s authorised Auditors Board.
1973-1982 - HKSA founded in 1973. - non-mandatory accounting standards were issued during this period. They were essentially re- issues of UK accounting standards - Securities Ordinance was first enacted in 1974, which established the securities commission and the office of the commissioner of securities to set up a legal framework for oversight of the markets.
Post 1982 -In 1982, the HKSA and UK CACA offered joint exams. -Formal standard setting structure was introduced in 1982. -HK accounting standards were issued based on the UK standards.
1984 The Companies (Amendment) Ordinance 1984 adopted the UK Companies Act 1948 which bought HK in line with the then statutory disclosure requirements in he UK providing greater disclosure of information to investors and creditors.
1986 -Unification of four stock exchanges to establish the Stock Exchange of Hong Kong (SEHK) in 1986. -Companies that are listed in Hong Kong also has to abide by most of the Ordinance’s requirements for financial reporting due to the SEHK’s listing rules. -Listed companies are required to comply with the accounting and reporting requirements of the SEHK.
1993 HKSA adopted an official policy to harmonize HK GAAP with IAS.
1994 -Formal standard setting structure introduced in 1982 was replace in 1994 by Accounting Standards Advisory Panel and the financial Accounting Standards Committee (FASC). - HKSA issued two types of financial accounting pronouncements: the mandatory statement of standard accounting Practice (SSAP) and the non-mandatory accounting guideline (AG) and Industry Accounting guideline (IAG).
Appendix 353
APPENDIX 3 NOTES ON ACCOUNTS Notes on the Accounts 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988 1987 1986 1985 1984 1983 1982 1981 1980 1979 1978 1977 1976 1975 1974 1973 1972 1971 1970 1969 1968 1967 Basis of preparation Hong Kong Statement of Standard Accounting Practice (HK S ● HK SSAP 32 'Consolidated Financial Statementso ● and Accounting f consolidated ●●●●●●●●●●●●●●●●● HK SSAP 24 ● HK SSAP 9 'Events after the Balance Sheet Date' Goodwill ●●●●●●●●● Consolidation ●● ●●● ●●●●●
All significant intra-group transactionse ●●●●●●●●●●● have be Nature of business ●●●●●●●●●●● Principal accounting policies Income recognition ●●●●●●●●●● Goodwill ●● Loan and advances and doubtful debts ●●●●●●●●●●` ●●●● ● Specific provision ●●●●●●●●●●● General provisions ●●●● Loans on which interest is being ●●●●suspended Non-accural loans ●●●● Securities ●●●●●●●●●●● Subsidirary and associated companies●●●●●●●●●●● ●●●●● ●● Tangible fixed assets ●●●●●●●●●●●●●●●●●●●●●●● ●●● ● ● Finance and operating leases ●●●●●●●●●●●●●●●●●●●●● Deferred taxation ●●●●●●●●●●●●●●●●●●●● Retirement benefits ●●●●●●●●●●●●●●●●●●● Foreign currency ●●●●●●●●●●●●●●●●●●●● ● ●●● ●●●●●●●●● Off-balance-sheet financial instruments●●●●●●●●●●●● Dividends ●●●● Cash and Cash equivalents ●●●● Investments ●●●●●●●●●●●●● Inner reserve ●●●● Long term assurance business ● Transition to IFRS ● Operating profit ●●●●●●●●●●●●●●●●●●●●●●●● ●●●●● Profit on tangible fixed assets and long-termm●●●●●●●●●●●● invest Exceptional profit ●
Appendix 354
2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988 1987 1986 1985 1984 1983 1982 1981 1980 1979 1978 1977 1976 1975 1974 1973 1972 1971 1970 1969 1968 1967 Taxation ●●●●●●●●●●●●●●●●●●●●● ●●
Profit attributable to shareholders ●●●●●●●●●●●
Dividends ●●●●●●●●●●●●●●●●●●●●●●●● ●
Earnings per share ●●●●●●●●
Retained profits ●●●●●●●
Cash and short-term funds ●●●●●●●●●●●●●●●●●●●●● ●
Placing with banks maturing after one●●●●●●●●●●● month ●
Certificates of deposite ●●●●●●●●●●●
Hong Kong currency notes in circulation●●●●●●●●●●●●●●●●●●●●●●●● ●●●●●●●●●●●●●
Securities held for dealing purposes●●●●●●●●●●● ●● ● ●●
Long-term investments ●●●●●●●●●●●●●●●●●●●●● ● ●
Advances to customers ●●●●●●●●●●●●●●●●●●●●●
Provisions for bad and doubtful debtsn ●●●●●●●●●●● against adva
Amounts due from subsidiary companies●●●●●●●●●●●
Amount due from fellow subsidiary companies●●●●●●●●●●●
Investments in subsidiary companies●●●●●●●●●●●●●●●●●●●●● ●●●● ●
Investments in associated companies●●●●●●●●●●●●●●●●●●●●● ●●●●
Tangible fixed assets ●●●●●●●●●●●●●●●●●●●●● ● ●●
Other assets ●●●●●●●●●
Current, savings and other deposit accounts●●●●●●●●●●●●●●●●●●●●● ●●●●●●●●●●●●●
Deposits by banks ●●●●●●●●●
Taxation (deferred taxation) ●●
Amounts due to subsidiary companies●●●●●●●●●
Amounts due to fellow subsidiary companies●●●●●●●●●
Other liabilities ●●●●●●●●●
Acceptances on behalf of customers ●●●
Provisions for liabilities and charges●●●●●●●●●
Loan capital ●●●●●●●●●●●●●●●●●●●●●
Share capital ●●●●●●●●●●●●●●●●●●●●●●●● ●●
Reserves ●●●●●●●●●●●●●●●●●●●●●●● ●●
Contingent liabilities, commitments ●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●and derivatives
Assets pledged as security for liabilities●●●●●●●●●● Reconciliation of operating profit tog ●●●●●●●●●●cash (used in)/
Appendix 355
2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988 1987 1986 1985 1984 1983 1982 1981 1980 1979 1978 1977 1976 1975 1974 1973 1972 1971 1970 1969 1968 1967 Analysis of cash and cash equivalents ●●●●●●●●●●
Capital commitments ●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●
Lease commitments ●●●●●●●●●●●●●●●●●●●●●
Segmental analysis ●●●●●●●●●●●●●
Loan to officers ●●●●●●●●●●●●●●●●●●●●●
details ●●●
Capital adequacy ratios Bank Ordiance ●●●
HKMA Guidelines on 'Maintenancee ●●●●●●●● of Adequat
Liquidity ratio Hong Kong Banking Ordinance ●●●●●●●●●●●
Stock-based compensation ●●●●
Comparative figures ●● ●●●●●● ●● ●
HK SSAP 15 "Cash flow statements" ● ●●
amendment ●●●●●
Foreign currency amounts ●●●●●●●●●●●●●●● ●●●●●●●●
Subsidiary companies ●●● ●●
Associated companies ●●● ●●
Ultimate holding company ●●●●●●●●●●●
Related party transactions exemption under Hong Kong Statement●●●●●●●●●●● of Asta
Change in Accounting policy (HK SSAP 24) ●
Approval of accounts ●●●●●●●●●●●●●●●●●
Director's fee ●●●●●●●●
Consolidated adjustment arising from revaluation of subsidiary companies ●●●
Post Balance Sheet Events ●●●●●●
Significant changes in Group structure ● revaluation ●●
Appendix 356
APPENDIX 4 FINANCIAL STATEMENTS OF HSBC 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 Consolidated Balance Sheet HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m ASSETS Cash and short-term funds 809 962 1,102 1,439 1,324 1,599 2,368 3,096 1,962 2,480 16,121 21,346 30,586 Money at call and short notice 1,241 1,152 1,601 3,096 4,008 3,948 6,106 8,356 11,399 10,381 Placing with banks maturing between 1-12 months 3,248 2,067 4,144 5,649 8,502 8,458 12,444 Trade bills 1,416 1,751 2,094 522 550 4,705 6,010 10,239 Certificates of deposit 4,292 5,574 4,699 Trade bills and Certificates of deposit 2,191 3,137 3,869 4,681 3,931 British and other governmnet treasury bills 375 627 493 484 499 Treasure bills 580 340 397 Hong Kong Government certificates of indeb 1,826 1,659 1,771 2,039 2,303 2,667 2,894 2,979 3,286 3,912 2,416 5,794 6,124 Securities held for dealing purposes 1,229 1,365 1,066 1,122 1,215 1,690 1,604 1,430 1,903 2,999 Investment securities 134 163 203 215 275 376 570 720 2,074 174 3,667 Advances to customers and other accounts 6,198 7,785 9,934 11,682 12,937 17,134 15,381 17,609 18,140 22,016 29,412 37,107 42,652 Amounts due from fellow subsidiary companies Amount due from ultimate holding company Balance of Remittances, drafts etc. in transit 5 25 34 99 Investment in associated companies 171 158 15 5 Investment in subsidiary companies Tangible fixed assets 206 210 216 267 287 524 408 497 1,552 2,369 2,464 2,341 2,742 Other assets Liability of customers for acceptances 2,162 2,634 3,120 3,735 3,686 4,652 6,805 8,213 10,337 11,249 12,161 14,337 16,839 15,601 18,308 21,601 26,294 29,672 37,040 44,576 49,487 57,821 66,262 80,479 98,391 125,292
LIABILITIES Hong Kong currency notes in circulation 1,886 1,719 1,830 2,098 2,362 2,725 2,953 3,038 3345 3,971 4,758 5,854 6,184 Current, deposit and other accounts 10,978 13,321 15,870 19,494 22,376 28,040 32,891 36,122 41,984 47,999 59,781 74,580 97,374 Deposit by bank Proposed dividend 37 37 50 51 59 69 96 125 168 197 277 346 Proposal cash bonus 6 0 Balance of Drafts & Remittances 8 80 137 122 182 388 791 95 371 Amounts due to fellow subsidiary companies 16 17 Amounts due to ultimate holding company Other liabilities Acceptances on behalf of customers 2,162 2,634 3,120 3,735 3,686 4,652 6,805 8,213 10,337 11,249 12,161 14,337 16,839 15,062 17,724 20,950 25,378 28,619 35,609 42,928 47,498 55,681 63,793 77,689 95,143 121,115
CAPITAL RESOURCES Loan capital from ultimate holding company Other loan capital Minority interests 43 49 60 72 84 119 139 148 169 196 304 370 468 Share capital 174 174 191 383 421 463 561 694 868 954 1,050 1,155 1,732 Share Premium Account Reserves 297 329 360 398 474 750 824 1,025 931 1,189 1,299 1,427 1,636 Proposed final interim dividend Shareholders' funds 471 503 552 780 895 1,212 1,385 1,719 1,799 2,144 2,348 2,582 3,368 Retained profits 25 32 40 64 74 99 124 122 163 129 138 295 341 514 551 611 853 979 1,332 1,524 1,867 1,967 2,340 2,652 2,952 3,836 15,601 18,308 21,601 26,294 29,672 37,040 44,576 49,487 57,811 66,262 80,479 98,391 125,292 Appendix 357
1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 Consolidated Profit and Loss Account HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m Interest income Interest expense Net interest income Other operating income Operating income Operating expenses Operating profit before provisions Provisions for bad and doubtful debts Provisions for contingent liabilities Operating profit Profit on disposal of tangible fixed assets and investment securities Exceptional profit Share of profits less losses of associated companies Profit on ordinary activities before tax Tax on profit on ordinary activities Profit on ordinary activities after tax 89 105 140 160 187 238 312 334 368 440 582 809 1,131 Minority interests -7 -9 -12 -16 -16 -21 -33 -33 -34 -46 -60 -82 -117 Profit attributable to shareholders 81 96 128 144 170 218 279 301 333 394 522 727 1,014 Retained profits at 1 Jan 1925224047334354868333136118 Exchange and other adjustment Transfer of depreciation to premises revaluation reserv -5 -2 -2 -3 -3 Consolidated adjustment -8 -11 -3 23 29 -9 -15 Realisation on disposal of premises and investment properties Change of accounting policy in respect of defined benefit retirement scheme Transfer to revaluation reserves Transfer to premises revaluation reserves Transfer to reserves -14 -25 -35 -37 -45 -38 -55 -75 -84 -110 -129 -198 -278 Dividends -56 -62 -73 -79 -89 -102 -141 -180 -201 -229 -273 -370 -513 Retained profit for the year 25 32 40 64 74 99 124 122 163 129 138 295 341
Consolidated Cash Flow Statement Operating activities Cash generated from operations Interest received from long-term investments Dividends received from long-term investments Dividends received from associated companies Interest paid on loan capital Dividends paid to minority interests Ordinary dividends paid Preference dividends paid Taxation paid Net cash inflow/(outflow) from operating activities
Appendix 358
1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 Investing activities HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m Purchase of long-term investments Proceeds form sale or redemption of long-term investments Purchase of tangible fixed assets Proceeds from sale of tangible fixed assets Net cash outflow in respect of acquisition of and increased shareholding in subsidiary companies Net cash outflow in respect of sale of subsidiary companies Purchase of business Purchase of interest in associated company Proceeds from share issue by subsidiary to minority interest Proceeds from sale of interest in associated company Loans made to associated companies Net cash inflow/(outflow) from investing activities Net cash inflow/(outflow) before financing
Financing Issue of non-cumulative irredeemable preference share capital Issue of loan capital Isse of prreference share capital Repayment of loan capital Repurchase of own shares by Hang Seng Bank Ltd. Net cash flow from financing Increase/(Decrease) in cash and cash equivalents
Ratios: Current ratio 1.025808 1.024797 1.024384 1.030017 1.030694 1.02929 1.034306 1.037981 1.013317 1.002229 1.004979 1.011216 1.01377 Return on asset (ROA) 1.61013 1.772209 1.83702 2.439111 2.481335 2.685524 2.775524 2.470319 2.815093 1.946027 1.713421 3.000581 2.723611 Return on equity (ROE) Liquidity ratio 24.62% 24.53% 24.49% 27.42% 30.23% 26.99% 37.56% 36.06% 38.60% 37.18% 42.28% 36.40% 42.52% Loan/deposit ratio 56.46% 58.44% 62.59% 59.92% 57.82% 61.11% 46.76% 48.75% 43.21% 45.87% 49.20% 49.75% 43.80% Capital/Assets ratio 3.18% 3.19% 3.01% 3.49% 3.55% 3.86% 3.70% 4.02% 3.68% 3.73% 3.47% 3.30% 3.33%
Earnings per share (EPS) 0.08 0.09 0.1 0.12 0.15 0.2 0.28 Dividend per share 0.03 0.04 0.05 0.06 0.07 0.1 0.13 Debt to Equity (D/E) 0.965435 0.968109 0.969855 0.965132 0.964527 0.961362 0.963041 0.95981 0.963155 0.962742 0.965329 0.966992 0.966657
Capital adequacy ratios Total capital/risk-weighted assets (%) Tier 1 capital/risk-weighted assets (%)
Liquidity ratio HK branches of the Bank (%)
Return on average shareholders' funds Post-tax return on average total assets Cost:income ratio Net interest margin Appendix 359
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 Consolidated Balance Sheet HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m ASSETS Cash and short-term funds 47,598 65,663 86,356 110,104 105,784 141,675 180,422 207,812 233,961 126,640 289,868 283,658 243,939 Money at call and short notice m 34,254 39,994 49,190 52,060 42,673 38,685 57,406 65,418 70,526 43,149 116,233 117,839 118,576 PlacingTrade bills with banks maturing between 1-12 12,620 13,965 12,961 17,967 18,257 21,279 26,085 30,742 35,361 20,125 43,773 37,265 39,598 Certificates of deposit Trade bills and Certificates of deposit British and other governmnet treasury bills Treasure bills Hong Kong Government certificates of indeb 7,314 8,574 9,824 11,064 11,694 14,174 16,994 22,444 26,674 31,204 34,704 40,134 50,584 Securities held for dealing purposes Investment securities 11,941 12,583 15,051 20,535 19,239 31,618 36,202 46,952 37,969 7,632 62,680 45,777 65,917 Advances to customers and other accounts 114,325 145,326 182,614 223,644 249,177 267,799 367,364 427,211 456,642 191,229 570,549 361,652 440,277 Amounts due from fellow subsidiary companies 46,330 16,858 14,418 Amount due from ultimate holding company 1,334 Balance of Remittances, drafts etc. in transit between offices Investment in associated companies 1,356 1,653 2,163 2,901 3,101 3,130 2,819 2,452 1,946 238 2,029 588 557 Investment in subsidiary companies 16,706 Tangible fixed assets 8,009 8,595 10,610 13,192 14,784 15,819 16,196 20,622 20,632 18,841 38,420 33,610 39,355 Other assets 369 484 691 917 1,996 3,273 3,615 Liability of customers for acceptances 5,166 7,369 9,726 17,931 14,902 8,158 8,181 242,953 304,206 379,186 470,315 481,607 545,610 715,284 823,653 883,711 502,094 1,158,256 938,715 1,013,221
LIABILITIES s 789 12,689 17,363 18,390 Hong Kong currency notes in circulation 7,374 8,634 9,884 11,124 11,754 14,234 17,054 22,504 26,734 31,264 34,764 40,194 50,644 Amounts due to ultimate holding company 694 2,950 Current, deposit and other accounts 216,117 269,707 335,479 411,280 422,403 481,025 637,509 745,228 795,635 392,620 1,041,964 832,229 862,349 Other liabilities 336 137 Deposit by bank Acceptances on behalf of customers 5,166 7,369 9,726 17,931 14,902 8,158 8,181 Proposed dividend 524 686 770 846 887 975 1,057 1,229 1,415 1,628 1,681 229,969 286,937 356,432 441,517 450,083 504,392 663,801 768,961 823,784 438,201 1,078,409 890,480 934,333 Proposal cash bonus Balance of Drafts & Remittances 541 573 CAPITAL RESOURCES Amounts due to fellow subsidiary companie Loan capital from ultimate holding company 3,186 3,487 4,438 12,567 16,977 18,650 20,757 11,224 20,027 11,458 11,689 Other loan capital 11,324 Minority interests 2,658 3,209 3,962 5,725 6,223 6,769 7,995 2,743 3,240 6,318 7,177 13,058 Share capital 2,786 3,899 5,200 5,720 7,150 7,865 9,438 11,818 13,102 14,540 16,161 16,254 16,254 Share Premium Account 1,562 263 Reserves 7,156 7,978 8,115 10,944 11,443 11,746 14,329 21,481 22,828 38,129 37,341 13,346 26,563 Proposed final interim dividend Shareholders' funds 9,941 11,877 13,315 16,664 18,593 19,611 23,767 33,299 35,930 52,669 53,502 29,600 42,817 Retained profits 385 621 2,028 2,922 2,270 2,271 2,744 12,599 16,648 20,726 25,876 29,254 38,947 48,739 54,692 59,927 63,893 79,847 48,235 78,888 242,953 304,206 379,186 470,315 481,607 545,610 715,284 823,653 883,711 502,094 1,158,256 938,715 1,013,221 Appendix 360
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 Consolidated Profit and Loss Account HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m Interest income 56,297 Interest expense -38,159 Net interest income 18,138 Other operating income 12,213 Operating income 30,351 Operating expenses -12,730 Operating profit before provisions 17,621 Provisions for bad and doubtful debts -6,549 Provisions for contingent liabilities Operating profit 11,072 Profit on disposal of tangible fixed assets and investment securities 5,061 Exceptional profit Share of profits less losses of associated companies 254 Profit on ordinary activities before tax 16,387 Tax on profit on ordinary activities -2,242 Profit on ordinary activities after tax 1,759 2,476 2,612 3,232 3,375 3,627 4,075 4,570 4,957 5,480 3,961 6,987 14,145 Minority interests -328 -473 -255 -740 -784 -908 -1,019 -977 -657 -706 -865 -1,118 -2,335 Profit attributable to shareholders 1,431 2,003 2,357 2,492 2,591 2,719 3,056 3,593 4,300 4,774 3,096 5,869 11,810 Retained profits at 1 Jan 132 154 1,169 2,028 2,922 2,270 2,271 2,744 3,912 0 Exchange and other adjustment 86 164 20 -72 30 9 -12 0 Transfer of depreciation to premises revaluation reserve Consolidated adjustment Realisation on disposal of premises and investment properties Change of accounting policy in respect of defined benefit retirement scheme Transfer to revaluation reserves Transfer to premises revaluation reserves Transfer to reserves -454 -540 -440 -504 -1,947 -1,199 -1,065 -639 -885 Dividends -724 -996 -1,144 -1,258 -1,316 -1,447 -1,548 -1,795 -2,094 -2,440 -2,518 -2,800 -5,400 r 385 621 2,028 2,922 2,270 2,271 2,744 3,912 5,221 2,334 578 3,069 6,410 Retained profit for the yea
Consolidated Cash Flow Statement Operating activities Cash generated from operations Interest received from long-term investments Dividends received from long-term investments Dividends received from associated companies Interest paid on loan capital Dividends paid to minority interests Ordinary dividends paid Preference dividends paid Taxation paid Net cash inflow/(outflow) from operating activities
Appendix 361
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 Investing activities HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m Purchase of long-term investments Proceeds form sale or redemption of long-term investments Purchase of tangible fixed assets Proceeds from sale of tangible fixed assets Net cash outflow in respect of acquisition of and increased shareholding in subsidiary companies Net cash outflow in respect of sale of subsidiary companies Purchase of business Purchase of interest in associated company Proceeds from share issue by subsidiary to minority interest Proceeds from sale of interest in associated company Loans made to associated companies Net cash inflow/(outflow) from investing activities Net cash inflow/(outflow) before financing
Financing Issue of non-cumulative irredeemable preference share capital Issue of loan capital Isse of prreference share capital Repayment of loan capital Repurchase of own shares by Hang Seng Bank Ltd. Net cash flow from financing Increase/(Decrease) in cash and cash equivalents
Ratios: Current ratio 1.024081 1.029295 1.033034 1.035499 1.034206 1.044588 1.048308 1.044307 1.047701 1.135698 1.038415 1.037461 1.066674 Return on asset (ROA) 1.58467 2.04138 5.348299 6.212857 4.713387 4.162314 3.836238 4.749573 5.90804 4.648532 0.499026 3.269363 6.326359 Return on equity (ROE) Liquidity ratio 38.89% 39.32% 39.16% 38.30% 34.62% 36.96% 36.90% 36.91% 38.46% 37.82% 38.84% 46.74% 39.69% Loan/deposit ratio 52.90% 53.88% 54.43% 54.38% 58.99% 55.67% 57.62% 57.33% 57.39% 48.71% 54.76% 43.46% 51.06% Capital/Assets ratio 5.34% 5.68% 6.00% 6.12% 6.55% 7.55% 7.20% 6.64% 6.78% 12.73% 6.89% 5.14% 7.79%
Earnings per share (EPS) 0.38 0.51 0.55 0.57 0.59 0.63 0.7 0.78 0.82 0.82 0.48 Dividend per share 0.18 0.24 0.26 0.29 0.3 0.33 0.36 0.38 0.35 0.42 0.39 Debt to Equity (D/E) 0.946559 0.943233 0.939993 0.938769 0.934544 0.924455 0.928024 0.933598 0.932187 0.872747 0.931063 0.948616 0.922141
Capital adequacy ratios Total capital/risk-weighted assets (%) 10.8 10.9 11.0 13.9 Tier 1 capital/risk-weighted assets (%) 6.39 6.47
Liquidity ratio HK branches of the Bank (%)
Return on average shareholders' funds 25 Post-tax return on average total assets 2 Cost:income ratio 42 Net interest margin Appendix 362
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Consolidated Balance Sheet HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m ASSETS Cash and short-term funds 287,395 287,578 315,583 314,056 315,427 379,451 416,922 455,193 344,637 322,305 359,137 501261 Money at call and short notice m 92,722 79,499 76,091 101,405 101,646 120,401 169,126 140,068 115,702 90,886 113,322 74481 PlacingTrade bills with banks maturing between 1-12 41,239 31,374 32,226 Certificates of deposit 10,592 11,102 20,610 17,278 21,120 32,308 34,359 34,468 53,290 56,893 57418 Trade bills and Certificates of deposit British and other governmnet treasury bills Treasure bills Hong Kong Government certificates of indeb 58,854 60,504 61,174 62,254 63,084 57,384 76,994 63,904 67,344 73,654 85,294 92334 Securities held for dealing purposes 11,348 15,134 22,484 21,278 19,518 24,258 57,711 74,384 87,468 82,239 71747 Investment securities 86,783 46,481 52,899 57,938 54,963 89,299 130,226 193,314 266,946 350,166 399,642 430469 Advances to customers and other accounts 512,815 505,910 548,632 616,142 749,457 682,638 636,251 652,503 674,557 721,775 815,004 919253 Amounts due from fellow subsidiary compan 13,932 9,176 9,957 5,659 8,474 8,117 23,056 23,723 22,095 22,087 57,389 82592 Amount due from ultimate holding company 334 57 3 2 Balance of Remittances, drafts etc. in transit between offices Investment in associated companies 523 556 1,551 1,884 2,078 1,543 1,480 1,641 1,566 1,499 1,564 16918 Investment in subsidiary companies Tangible fixed assets 36,970 35,903 48,164 57,426 54,298 40,886 42,666 44,251 40,967 37,988 34,875 42080 Other assets 34,812 87,466 57,218 84,605 95,303 100,075 106,606 143,382 170492 Liability of customers for acceptances 1,131,567 1,078,978 1,172,516 1,294,672 1,475,449 1,477,575 1,637,892 1,761,970 1,742,741 1,867,724 2,148,741 2,459,045
LIABILITIES Hong Kong currency notes in circulation 58,914 60,564 61,234 62,314 63,084 57,384 76,994 63,904 67,344 73,654 85,294 92334 Current, deposit and other accountss 969,53012,540 910,811 13,291 984,065 12,429 983,913 11,993 1,068,789 8,066 1,167,534 6,246 1,263,3596,813 1,395,7 7,29102 1,378,119 11,417 1,473,539 11,052 1,669,704 11,328 1880673 17137 DepositAmounts by due bank to ultimate holding company 523 452 4,653 46,393 591 75,436 424 50,298 462 47,198 452 38,130 595 47,717 480 45,545 441 68,111 375 73098 479 ProposedOther liabilities dividend 3,500 3,500 4,500 60,806 5,400 126,538 5,300 82,118 2,551 121, 8,217834 131,703 7,277 118,847 0 137,983 175,071 220327 ProposalAcceptances cash on bonus behalf of customers Balance of Drafts & Remittances 1,045,007 988,618 1,066,881 1,171,410 1,347,637 1,366,593 1,524,867 1,644,602 1,623,924 1,742,214 2,009,883 2,284,048 Amounts due to fellow subsidiary companie CAPITAL RESOURCES Loan capital from ultimate holding company 11,667 9,748 5,992 5,994 2,906 2,905 2,915 2,925 2,924 2,924 0 11142 Other loan capital 14,484 14,570 14,131 13,929 13,771 13,982 14,567 14,374 14,828 15,368 12,855 Minority interests 12,887 14,703 17,672 19,909 19,966 17,268 16,057 16,257 17,936 17,060 15,991 16360 Share capital 16,254 16,254 16,254 16,254 16,258 16,258 16,258 16,258 44,937 44,940 51,603 74213 Share Premium Account Reserves 31,268 35,085 51,586 67,176 74,911 60,569 63,228 67,554 38,192 42,694 49,959 68482 Proposed final interim dividend 3,500 8,450 4800 Shareholders' funds 47,522 51,339 67,840 83,430 91,169 76,827 79,486 83,812 83,129 91,134 110,012 147495 Retained profits 86,560 90,360 105,635 123,262 127,812 110,982 113,025 117,368 118,817 126,486 138,858 174,997 1,131,567 1,078,978 1,172,516 1,294,672 1,475,449 1,477,575 1,637,892 1,761,970 1,742,741 1,868,700 2,148,741 2,459,045 Appendix 363
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Consolidated Profit and Loss Account HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m Interest income 52,359 56,260 74,894 76,882 90,528 103,884 90,656 104,653 83,586 59,194 55,770 57911 Interest expense -31,253 -34,701 -49,619 -46,800 -57,183 -70,696 -55,703 -67,013 -44,312 -19,549 -17,032 -19679 Net interest income 21,106 21,559 25,275 30,082 33,345 33,188 34,953 37,640 39,274 39,645 38,738 38,232 Other operating income 13,547 10,876 12,858 14,453 16,807 15,714 15,282 17,399 18,351 18,671 22,627 29421 Operating income 34,653 32,435 38,133 44,535 50,152 48,902 50,235 55,039 57,625 58,316 61,365 67,653 Operating expenses -13,452 -13,856 -15,330 -17,597 -19,428 -18,619 -19,236 -20,453 -22,040 -22,495 -24,024 -26992 Operating profit before provisions 21,201 18,579 22,803 26,938 30,724 30,283 30,999 34,586 35,585 35,821 37,341 40,661 Provisions for bad and doubtful debts -3,850 -174 -740 -1,443 -4,546 -12,531 -7,847 -1,355 -2,257 -2,251 -3,386 812 Provisions for contingent liabilities 0 -49 -50 -222 -143 -89 -78 0 -76 -43 Operating profite 17,3512,366 18,405 2,262 22,063 1,306 25,446 1,311 26,128 1,921 17, -289530 23,009 1,822 33,142 1,275 33,250 1,289 33,570 377 33,879 1,013 41,430 2098 ProfitExceptional on disposal profit of tangible fixed assets and investm 4,559 -971 -263 54 -36 -371 -234 1024 Share of profits less losses of associated companies 93 77 120 229 225 182 127 165 132 85 139 414 Profit on ordinary activities before tax 19,810 25,303 23,489 26,986 28,274 16,452 24,695 34,636 34,635 33,661 34,797 44,966 Tax on profit on ordinary activities -3,628 -3,536 -3,766 -4,401 -4,848 -3,102 -3,625 -4,917 -4,479 -4,024 -5,387 -7086 Profit on ordinary activities after tax 16,182 21,767 19,723 22,585 23,426 13,350 21,070 29,719 30,156 29,637 29,410 37,880 Minority interests -2,589 -2,860 -3,096 -3,331 -3,629 -2,565 -3,165 -3,754 -3,919 -3,782 -3,613 -4315 Profit attributable to shareholders 13,593 18,907 16,627 19,254 19,797 10,785 17,905 25,965 26,237 25,855 25,797 33,565 Retained profits at 1 Jan 45,314 41,265 44,818 19,980 28,579 37764 Exchange and other adjustment -155 -764 -206 517 1,089 777 Transfer of depreciation to premises revaluation reserve 274 321 357 344 240 298 Consolidated adjustment Realisation on disposal of premises and investment properties 15 308 62 109 233 519 Change of accounting policy in respect of defined benefit retirement scheme 576 1,191 Transfer to revaluation reserves -818 Transfer to premises revaluation reserves -273 Transfer to reserves Dividends -8,000 -14,090 -10,500 -12,000 -12,500 -9,751 -22,088 -22,277 -51,288 -18,802 -18,274 -21840 Retained profit for the year 5,593 4,817 6,127 7,254 7,297 1,034 41,265 44,818 19,980 28,579 37,764 51,083
Consolidated Cash Flow Statement Operating activities Cash generated from operations -18,726 33,430 19,052 29,469 109,103 98,059 117,284 52,194 38,255 76,379 124185 Interest received from long-term investments 3,806 2,797 4,488 3,975 7,689 9,955 10,516 13,278 11,826 12,496 12780 Dividends received from long-term investments 43 37 84 110 72 62 82 209 216 210 Dividends received from associated companies 671085852 Interest paid on loan capital -1,179 -1,164 -1,494 -1,200 -1,075 -1,003 -1,133 -1,069 -918 -835 -576 Dividends paid to minority interests -1,347 -2,008 -2,669 -2,426 -2,518 -5,588 -3,259 -3,548 -3,549 -4,634 -3693 Ordinary dividends paid -14,090 -9,500 -11,100 -12,600 -12,500 -16,171 -23,000 -56,389 -14,000 -12,150 -23950 Preference dividends paid 0 -251 -217 -277 -1,438 -1,140 -1269 Taxation paid -3,903 -4,312 -3,115 -3,235 -2,976 -1,834 -3,546 -3,035 -3,018 -3,619 -5083 Net cash inflow/(outflow) from operating activities -35,396 19,280 5,246 14,093 97,795 83,229 96,727 1,221 27,475 66,771 102,656 Appendix 364
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Investing activities HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m HK$m Purchase of long-term investments -62,475 -37,574 -65,919 -102,104 -191,130 -196,309 -305,490 -328,106 -311,021 -323,578 -289347 Proceeds form sale or redemption of long-term investments 83,717 35,407 65,208 104,047 151,684 160,621 236,865 243,596 229,460 299,295 268963 Purchase of tangible fixed assets -1,077 -2,251 -1,912 -2,029 -6,288 -1,694 -1,824 -1,641 -1,294 -1,220 -1475 Proceeds from sale of tangible fixed assetso 5,090 769 1,129164 482 0 654 487 -7 116 -406 428 9 196 -158 216 -176 443 842 39 NetNet cash cash outflow outflow in inrespect respect of of acquisition sale of subsidiary of and increased companies shareh -81 36 -76 193 213 -23,541 -795 -972 Purchase of business -70 -7 -60 -7,787 -588 Purchase of interest in associated company -15 -55 -8 1 0 -78 23 -18 -122 -15785 Proceeds from share issue by subsidiary to minority interest 114 Proceeds from sale of interest in associated company 25 3 -34 164 1 2 12 Loans made to associated companies -209 Net cash inflow/(outflow) from investing activities 25,928 -3,353 -2,111 762 -45,229 -37,747 -69,880 -109,515 -82,874 -33,762 -38,311 Net cash inflow/(outflow) before financing -9,468 15,927 3,135 14,855 52,566 45,482 26,847 -108,294 -55,399 33,009 64,345
Financing Issue of non-cumulative irredeemable preference share capital 28,679 0 6240 Issue of loan capital 1,970 0 357 676 308 6,808 16356 Isse of prreference share capital 3,863 Repayment of loan capital -4,069 -4,129 -3,100 0 0 -5,925 -1771 Repurchase of own shares by Hang Seng Bank Ltd. -1,252 -50 Net cash flow from financing 1,970 0 0 -489 -50 357 0 29,355 308 883 20,825 Increase/(Decrease) in cash and cash equivalents -7,498 15,927 3,135 14,366 52,516 45,839 26,847 -78,939 -55,091 33,892 85,170
Ratios: Current ratio 1.060714 1.069958 1.071016 1.095093 1.099848 1.079595 1.082287 1.078008 1.072676 1.081867 1.080837 1.097927 Return on asset (ROA) 4.942703 4.46441 5.225515 5.602964 4.945613 0.699795 25.19397 25.4363 11.4647 15.30151 17.57494 20.77351 Return on equity (ROE) 0.291908 Liquidity ratio 37.24% 37.91% 37.10% 33.68% 29.44% 35.26% 37.75% 35.73% 28.39% 24.98% 24.64% 25.75% Loan/deposit ratio 52.89% 55.55% 55.75% 62.62% 70.12% 58.47% 50.36% 46.75% 48.95% 48.98% 48.81% 48.88% Capital/Assets ratio 7.65% 8.37% 9.01% 9.52% 8.66% 7.51% 6.90% 6.66% 6.82% 6.77% 6.46% 7.12%
Earnings per share (EPS) 14 16 12 Dividend per share 667 Debt to Equity (D/E) 0.923504 0.916254 0.909907 0.904793 0.913374 0.924889 0.930994 0.933388 0.931822 0.932313 0.935377 0.928835
Capital adequacy ratios Total capital/risk-weighted assets (%) 14.4 14.9 15.1 15.4 14.4 14.6 14 13.2 13 12.7 12.1 11.9 Tier 1 capital/risk-weighted assets (%) 9 9.4 9.8 9.4 10.3 9.6 9.4 9.5 9.8 10.3 11.4
Liquidity ratio HK branches of the Bank (%) 38.6 38.8 47 54.1 51.1 49 41.7 Return on average shareholders' funds 30.1 28.6 29.2 26 22.4 12.5 22.7 33.3 30.1 30 27.4 27.5 Post-tax return on average total assets 1.71.71.81.931.680.911.351.771.731.651.461.66 Cost:income ratio 38.8 42.7 40.2 39.5 38.7 38.1 38.3 37.2 38.2 38.6 39.1 39.9 Net interest margin 2.56 2.84 2.73 2.56 2.56 2.55 2.57 2.54 2.24 1.98