Digital Banks

Digital banks are banking establishments without brick-and-mortar presence. Technically, this would be unimaginable say twenty years ago. How can we be able to make what we called as bank transactions without the need of a physical bank? Thanks to the huge advancement in fintech (financial technology) developments, it has made it so convenient that one almost need not have to go to a bank to do many types of transactions, apart from the compulsory ones like opening or closing of accounts. Almost all our ‘conventional banking transactions’ can now be carried out online.

Naturally, the banking scene in Singapore has to move along with the changing times. Monetary Authority of Singapore (MAS) will be issuing two Digital Full Bank (DFB) and three Digital Wholesale Bank (DWB) licences for operating digital banks in Singapore. To date, 21 participants have submitted their applications in a bid for the 5 licences. The results will only be known by the middle of the year. Except for Sea Group, ByteDance and Art Financial who applied for the respective licence in solo, all the other applicants are newly-formed consortiums backed up by financially deep-pocket corporations. The results of the successful applicants will only be known by 20 June 2020.

But then, what is the impact on us as individual bank customers, business owners and incumbent bank shareholders amidst the dynamic business environment and the restrictions imposed by the regulators? As always, there is no fixed answer to this question. The only way to break down the issue and analyze them accordingly.

  1. Digital Full Bank (DFB) licence

The DFB licence permits the holder to take in deposits and operates like a brick-and-mortar bank. However, this can only happen when everything is in a ‘steady-state’ at least 3-5 years down the road after commencing operation. Before the DFB licence holder can reach this stage, it has to pass a series of ‘litmus tests’ to establish if the DFB can sustain itself as a full-licence digital bank.

While the paid-up capital for the first few years of operations is fairly low at $15 million, the real hurdle is the ceiling or the cap on the aggregate deposit and individual deposits. The imposed aggregate deposit of $50 million certainly pales against the incumbent banks’ deposits of between $290 billion and $380 billion based on their FY 2018 annual report. As it is, the cap on each deposit stands at $75,000, and this can only be come from the shareholders, employees and related parties. Subject to banks’ capital ratio requirements, it also means that there is a limit in which the DFB can lend out.

At the first instant, the conditions may appear to be very draconian. How can the digital banks compete with the existing goliaths? Why does the authority even bother to issue out digital bank licences only to make the DFBs unable to survive?  First and foremost, the idea of having digital banks is not to take away businesses from the existing brick-and-mortar banks. If, by doing so, means using digital banks are able to chip away businesses from existing banks, then it totally missed the whole point of having digital banks. In fact, any simple person would have envisaged that DFBs would raise the deposit rate to attract funds even at the expense of their short-term profitability. Certainly, this will cause huge disruptions to the incumbent banks as there is a huge pool of depositors looking for higher interest rates to park their money. This is not what the authority wants to achieve. Their primary objective is to enable the non-bank corporates to innovatively create products for the unmet, un-serve or the under-serve segments, in particular the SMEs. That explains why the initial deposits have to come from the DFB’s shareholders, their employees and the related parties and not any other depositors looking for higher interest rates. The relatively small aggregate deposit of $50 million also presents a challenge for the DFB to bit-size their loans to mitigate their lending risk, and to make use of their enterprising experience in non-bank businesses to make the DFB work. It is only after these restrictions are lifted, perhaps 3-5 years down the road, before the DFBs can operate as a full-fledge digital banks co-existing with the incumbent brick-and-mortar ones. Only then would the paid-up capital be increased to $1.5 billion. Perhaps, the final paid up capital requirement may not be the real issue as most of the applicants are backed up by deep-pocket corporates. However, to build up the whole eco-system to match that of the incumbent banks remain an uphill task. Thus, in the retail space, at least, the incumbent banks have a 3-5 years lead before they are subject to the real competition from the DFBs. In fact, in the last few years or so, the incumbent banks have already built sufficiently strong ecosystems well-protected by thick firewalls for the DFBs to break through. This should serve as an excellent economic moat against the DFBs for the time being.                 

  • Digital Wholesale Bank (DWB) licence

Unlike the DFB, the DWB capital requirement is lower and so is the foreign ownership restrictions.  Although head-quartered in Singapore, the motivation really is to serve the Asean region, which is generally underserved. The paid-up capital for DWBs is $100 million, which in my opinion, is not high in view that most of the applicants have deep-pocket financial backers. While the DWBs are not allowed to take in Singapore dollar deposits, they can take in current account deposits. So, if they are able to correctly provide the market with the right offers, then they are just as good as the DFBs. In fact, given that the DWBs are not subject to any deposit caps, they may even able to surpass the DFBs in terms of aggregate deposit. More so, is the fact that current account deposits attract less interest, meaning that the DWBs, in effect, have a lower cost of fund.

The battleground

For the start, the battleground for the digital banks, or digibanks in short, can be lumpy, fill with potholes and can be quite piecemeal. Given the incumbent banks’ long existence in the local scene, the juicy parts of the whole traditional banking business have already been sapped out. In the local deposit space, the incumbent brick-and-mortar banks made up of the three local banks, foreign full-licence banks and finance companies have already laid their hands in it. In fact, it was said that 98% of Singaporeans above the age of 15 years old have already have a bank account. However, that cannot be said of the region at the moment. More than two-third of the population in Myanmar, Vietnam, Indonesia and Philippines do not have a bank account. So, in the long-term when the DFBs become full-fledged digibanks, they could possibly slice out a piece of the pie of these un-served individuals, just like what the local brick-and-mortar banks have been doing in the recent years.

Then there are changes in consumer behavior and the rise in the use of apps. All these have a part to play in levelling the playing field between the digibanks and the traditional ones. Paper cheques are now push into near-obsolescence. Many, if not all, C2B payments can be made via credit cards, bank-apps, ecommerce platforms and e-wallets rendering all these transactions to become cashless, and blurring the functions between a bank or a recipient company. This is where the strengths of ecommerce companies strength are. Shopee, whose parent company SEA is one of the several ecommerce applicants for a DFB licence, has 100 million mobile users under its belt. This could easily dwarf the 10 million DBS bank customers by 10:1. In fact, all the participants vying for the digibank licences have huge data bases many times the population of Singapore. While the incumbent banks have a lead in terms of their digitization investments, the digital banks have parents, who possess a huge network of consumer data.

Finally, there is the SME segment. Whether B2B, C2B or B2C transactions, they have been made so seamless that we almost do not need, or at least, to perceive not to require a bank intermediary for these transactions. While the physical banks have entrenched deeply in this space, I think it is only a matter of time that the deep-pocket digibanks could close up the gap. In fact, I think this space could be the first cross-fire between the brick-and-mortar banks and the digibanks when they commence operations.

Effect on the brick-and-mortar banks

Certainly, it would be too naive to pretend that digibanks have no effect on the profitability of the brick-and-mortar banks in the long run. There will certainly be some impact if everything remains static. A lot depends on how the development of the digibanks is going to pan out and what the incumbent banks are doing to maintain their lead. If the incumbent banks are able to continue to successfully penetrate into the foreign markets while maintaining the stronghold position in the local scene, then the impact of the digibanks on the incumbent banks may not be so great or even negligible. That said, we should not forget that our neighbouring countries, are also planning to issue out digital bank licence pretty soon. That again could hamper the market development of both the brick-and-mortar banks and the digibanks going forward.                          

Disclaimer – The above points are based on the writer’s opinion. They do not serve as an advice or recommendation for readers to buy into or sell the mentioned securities. Everyone should do his homework before he buys or sells any securities. All investments carry risks.

Brennen has been investing in the stock market for 30 years. He trains occasionally and is a managing partner for BP Wealth Learning Centre. He is the instructor for two online courses on InvestingNote – Value Investing: The Essential Guide and Value Investing: The Ultimate Guide. He is also the author of the book – “Building Wealth Together Through Stocks” which is available in both soft and hardcopy.

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