Digital banks face critical mass challenges

Countries like India and Indonesia are ideally suited for digital banks but hitting the mass required for a viable business could be tricky, Fitch says

Digital banks face critical mass challenges
A passenger walks past an advertisement for WeBank in Shanghai in September 2018. The Chinese digital-only bank was valued at $21 billion at that time and had written more than 100 million loans in its first five years in business. It was set to expand its services to Australia. Photo: DYCJ / Imaginechina via AFP.

(ATF) Asian markets with low banking services penetration like India, Indonesia and the Philippines, are ideally suited for digital banks but hitting the critical mass required for a viable business will be tough, Fitch Ratings said.

“These countries are among the worst affected by the pandemic in the region, and even in the longer term, their potential may be hampered by lagging digital infrastructure,” Fitch analysts said in a note.

“Moreover, there remains a risk that aspiring virtual lenders may 'misprice' credit risks when targeting the unbanked, notwithstanding their potentially more advanced data analytics capabilities.”

Digital banks, even in the markets with established infrastructure will face challenges.

“Although some digital banks in APAC [the Asia-Pacific] have already turned profitable, such as Tencent-backed WeBank in China and the eponymous KakaoBank in Korea, most digital-only lenders’ risk frameworks and business models have not been tested through the economic cycle,” they said.

But those digital banks that are able to survive or thrive through the downturn are likely to be better-resourced and may pose a greater competitive threat over the medium term to digitally unprepared rivals.

“We would view smaller banks in jurisdictions with weaker digital banking capabilities as being more vulnerable to such disruption,” but said out-investing established players would be difficult in markets like Australia, Hong Kong, Japan and Singapore.

Downturn testing some virtual banks

Fitch said the current steep downturn could reveal weaknesses in the approaches of some virtual banks such as UK-based online bank Monzo, whose viability is now under a cloud.

“The virtual banks likely to provide more formidable competition for incumbents over the medium term include those backed by established technology platforms, such as Facebook or Alibaba, or deep-pocketed corporates, such as Reliance or Singtel,” Fitch said, explaining that they had the necessary funds for heavy financial investment necessary for entrants to attain scale, maintain cost competitiveness and survive the initial loss-making stages of a start-up.

“Strong name recognition associated with the parent may also help to generate credibility and aid in building a customer base, as well as providing potential synergies that may give the lending business a competitive edge.”