Pitfalls, challenges in the digital banking industry


WHILE digital banking seems like an exciting venture, it is a challenging business and there is no certainty that any licence holder will make a profitable venture out of it.

As one global consulting firm points out, among the pitfalls of digital banks include those that had set too high customer acquisition costs and those which based their selling proposition on lower rates than traditional banks. The firm points out that going down those routes will prove unsustainable in the long run.

Other pitfalls include insufficient access to funding and depending solely on the wholesale markets. Lastly, there are also cases where new digital banks have spent too much on building technology and a failure to use commercially available technologies.

This had resulted in too high costs, the global consulting firm tells StarBizWeek.

It adds that winners have included basic banking players which have identified their target markets and built differentiation in their services and user experience.

Examples of these are Starling Bank, TymeBank and Tinkoff Bank. Another group of successful digital banks are platform players such as WeBank, MyBank and Kakao Bank who have been able to leverage their captive customer base, big data and eco-systems to offer unique products and services at a much lower cost. Finally specialist players such as Oak North, Square and Open got their model right by leveraging their superior knowledge of their customers to deliver personalised capabilities.

Meanwhile, Justin Ong, Deloitte Malaysia’s innovation and regulatory leader says that from as early as 2013, Europe was leading in terms of digital banks or “challenger banks”.

“These challenger banks gained traction and popularity at an early stage, with the largest European challenger bank, Revolut having 13 million customers and Monza Bank reportedly gaining 55,000 new customers every week at its peak”.

But Ong adds that the economic downturn caused by Covid-19 has affected the profitability of challenger banks, with many reporting heavy losses in 2020.

He says that there has also been increasing complaints from customers about services from these challenger banks.

“Despite their early success, challenger banks struggle with scalability and consistency, having to compete with incumbent banks, and at the same time having to comply with regulations put in place for incumbent banks.

“With this, there is a rise in a new wave of challenger banks taking a more focused approach, targeting smaller customer segments, or offering more streamlined products to maintain consistency and maximise profits, ” says Ong.

Ong also points out that the timing of Malaysia’s digital banking journey coincides with the Covid-19 pandemic where there is an increasing reliance on technology but at the same time, a decline in economic conditions.

“Only time will tell if digital banks will thrive in the existing environment locally, ” he says.

PwC Malaysia financial services technology consulting lead Ravi Kittane says digital banks have been a fairly recent phenomenon and the firm has learned a lot especially since digital banks have been stress-tested early in their evolution with the pandemic.

Among key takeaways are that superior user experience and technology, while essential for a digital bank to attract and retain customers, is not a competitive advantage as competitors, both conventional and digital, can easily replicate it.

“Products should be designed to be simple, easy to use and understand and delivered digitally with minimal or even no human intervention.

“This will ensure that the bank can maximise customers at a lower marginal cost, ” says Ravi.

In a January 2021 report, McKinsey & Company pointed out that digital banking in Asia is prime for growth and throws up a lot of opportunities for players getting into the space.

“Amid soaring demand for online and mobile alternatives, new digital players are shaking up the market and transforming banking for individuals and companies.

“As regulators increase licence allocations and set standards for a new generation of banking, there is a unique opportunity for both incumbents and new entrants to get involved”, it says.

Interestingly, McKinsey notes that while digital banking players in other markets tend to be start-ups, Asian digital banking is being driven largely by established companies and consortia.

The latter brings the advantage of helping the digital bank achieve scale.

“Just five years after launch, Tencent-backed WeBank serves some 200 million people, and Alibaba-supported MYbank has more than 20 million SME customers. Over a short period, China’s digital banks now have a roughly 5% share of the country’s 5 trillion yuan (RM3.2 trillion) unsecured consumer loan market and more than 7% of online SME loans.

“South Korea’s KakaoBank, launched in 2017, attracted more than 10 million customers in its first year and now has a roughly 5% share of the country’s unsecured consumer loan market, ” McKinsey says.

The consulting firm points out that the pandemic has not shifted the path for digital banking in Asia. Last year, all virtual banks in Hong Kong managed to launch, along with Rakuten Bank in Taiwan China in early 2021. “Singapore’s regulator shortlisted four candidates for new digital banking licenses and Malaysia and the Philippines finalised their digital banking frameworks and guidelines.”

It also says that as digital banking matures, regulation tightens.

“In China, for instance, regulators have introduced additional rules related to risk management as well as limitations on online micro-lending business, ” McKinsey says.

The consulting firm notes that digital banking in Asia is competitive and that many startups have failed to scale sufficiently, or have scaled but not made a profit.

‘In aggregate, however, Asian digital banking has been a success. Japan’s Jibun bank, the first Asian digital pure play (launched in 2008), reached profitability less than five years after launch. China’s WeBank and XW Bank and South Korea’s KakaoBank produced positive returns two years after launch. All five Chinese digital banks were profitable in 2019, with WeBank and XW bank posting ROEs of about 28% and 30% respectively, compared with a national average for all banks of roughly 11%, ” McKinsey points out.

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