By Smita Aggarwal and Tilman Ehrbeck
Originally published on Tech Collective SEA
Challenger banks – digital only, mobile first, without costly branch network or cumbersome legacy IT – are all the rage in the region: Singapore is about to grant 5 new digital bank licenses, two of which are expected to be consumer banks. Hong Kong already has issued 8 new digital bank licenses. Malaysia has announced guidelines for issuance of 5 new digital banks. In the Philippines, a first digital bank is going live, while the Central Bank is preparing formal guidelines to enable more digital banks. And in Indonesia, many banks aim to transform themselves into digital-first. Can these newcomers be game changers or will they represent old wine in new bottles?
Accelerated by the pandemic and its economic fallout, the tale of retail challenger bank models in much of the rest of the world has been diverging. In the Americas, Albo, Chime, and Uoala have all reported record user numbers as consumers adapted to a “no-touch” economy. Aspiration and Varo announced successful equity fund raising rounds. In the U.K., by contrast, Revolut had to lay off people and Monzo was forced to accept new funding at a 40% lower valuation. What’s going on? And what does this mean for the future of digital challenger banks in Southeast Asia?
As always, market environment, business model, industry structure and economics, as well as regulatory context matter. The U.S. has a big domestic market with large, attractive custom tapped into the former segment, offering a free checking account with no hidden fees and attractive features, such as an immediate crediting of the paycheck forgoing the 2-3 days float that mainstream banks benefit from at the expense of their customers. Aspiration is going after the green customer segment, with features such as planting a tree for any rounded-up debit card purchase or offsetting customer carbon footprint at the gas pump.
Average debit card interchange fees in the U.S. at 1.2% of transaction value are high enough to pay for the tech platform. Both Chime and Aspiration function essentially as bank accounts for the customers at the front-end interface, but have been able to structure themselves capital-efficiently. Chime’s deposit balances are held by back-end banking partners. Aspiration’s core vehicle is a cash management account under a FINRA brokerage license, also administered by a bank partner at the backend. Similarly, In Latin America, Albo in Mexico or Neon in Brazil target a younger, lower-income segment that is willing to make the challenger bank cards their primary spending vehicle, and the debit interchange fee is high enough to make the economics work.
This is not the case in Europe. With near-instant retail payment settlement among bank current accounts and under tighter regulatory caps, debit card interchange fees are much lower at 0.2% of transaction value. To pay for their platforms, European challenger banks need other sources of revenue. Many are betting on credit and that’s why a number of them, such as Atom and Tandem in the U.K., acquired full banking licenses before launching, despite the costly and lengthy process. Others, like Starling Bank and Tide, have set their sights on the more lucrative SME banking segment.
By contrast, Monzo and Revolut started with a prepaid card before obtaining a deposit-taking bank license. Both have focused largely on the younger, affluent, cosmopolitan customer segment, who use them as a secondary service to pay friends, spend abroad (at favorable exchange rates) and set budgets. Only 20% of Monzo’s customers use it exclusively, most of the rest rely on traditional banks for their primary account. With COVID-19, discretionary spending in this target segment, which constituted a bulk of the transactions on Monzo and Revolut, has collapsed, putting relatively more pressure on these two London-based challenger banks.
Why Southeast Asia is different from the rest
The Southeast Asian context is different from the U.S. and the U.K. 70% of the 650 million people in the region are still unbanked. So, the key pain points are not high fees or bad service, access itself is still the biggest issue. Digital banks with lower cost structure and easy reach through digital-first processes can now address customers, who were not viable for a traditional bank. Southeast Asia is also home to a large micro and small business base comprising almost 90% of population and contributing 30-50% of GDP. These small businesses are still largely excluded from the formal financial sector. The pandemic has accelerated consumer and small business willingness to go digital, and the time is ripe for reinvention of banking in the region.
To succeed, new, digital-only banks in Southeast Asia need to address several issues:
- Customer onboarding and scale: The sweet spot for the new banks is to target the unbanked and underserved customer segments like gig workers, MSMEs, rural households or millennials. The key is to make banking ubiquitous and extending it into the day-to-day activities of the customers. Customers are looking for contextual financial products offered seamlessly with real-life use cases. Large tech platforms or apps with frequent engagement with customers could be good onboarding ramps for low-cost customer acquisition.
- Path to profitability: Unlike the U.S., where fees on payment transactions are high enough to support the cost of challenger banks, monetization in Southeast Asia would predominantly be through credit. Indonesia and Philippines have credit-to-GDP ratios of less than 50% indicating large unmet demand. Digital banks would need to be creative in designing credit solutions based on underlying cash flows instead of loans secured by collateral, in order to reach the vast majority of economically active but excluded populations.
- Capital requirements: Unlike U.S. and U.K., where there are many examples of capital- efficient challenger banks that partner with balance-sheet players at the back-end, regulators in Asia are encouraging well-capitalized, licensed digital banks with approval to take deposits and offer loans. Given the huge gap in availability of wholesale debt in the region, a deposit-taking license is a positive, but it also means a need for continuous access to equity capital.
Historically, existing retail banking relationships have been very sticky, and it is difficult to wean customers away from their existing bank. The big opportunity in Southeast Asia is to offer a completely new way of accessing and using financial services to many for the first time and fuel their economic advances. The keys to building a sustainable challenger bank business in Southeast Asia are low costs, user-centric design, and winning the trust of these new customer segments.