The Emergence of Digital Banks

The Emergence of Digital Banks

Money – we all need it, we all have some of it, and we all definitely want more of it. Yet money is a made-up concept based on the most capricious of human traits: trust. Most currencies have long abandoned any links to valuable assets like the gold standard  and in recent times has even shed its tangible form. Our personal net worth, the holdings of large NMCs and even a country’s national reserves are all almost entirely based on a system of digitised binary signals sequestered behind the walls of the most conspicuous institutions of human civilisation, banks. These venerated institutions often occupy the most prominent locations in the city, emblazoning the skyline with their logos, looming large in the center of business districts with their facades of corinthian columns in gleaming white Italian marble. However, these steadfast institutions are feeling the foundations of their ivory towers being shaken by the digital revolution.

The Digital Bank Challenge

The decade old financial crisis of 2008 besmirched the reputations of traditional banks and left an indelible mark upon both its customers and investors, leading to the birth of the first Fintech start-ups in the midst of bailouts and austerity measures. Fully digital banks like Atom and Revolut in the UK, and Germany’s N26 were the first to lead the charge in disrupting their brick-and-mortar rivals in the early years of this decade. In the next few years this new wave of challenger banks arrived on Eastern shores. China, Hong Kong and now, Singapore, is jumping onto the bandwagon.

The accepted status quo of the banking industry does not apply to digital banks. They are the free spirits of the finance industry, willing to explore new ideas and fresh new ways of doing business while still striving to make it all commercially sound. Leveraging heavily on technology, these upstart start-ups bring the bank teller window to the client via the smartphone. Opening accounts, forex transactions, insurance, loans and other financial services are made simpler, quicker and cheaper. Digital banks operate leaner, nimbler and more efficiently and have adapted to meet the demands for around-the-clock convenience from today’s consumers. This makes up a large part of their appeal as they are able to serve a greater pool of clients or niche group of clients that traditional banks have largely ignored due to inflexible customer profiling and entrenched practices. More importantly, costs are lower because traditional infrastructure is not needed, and neither is the corresponding manpower to facilitate it. This allows basic services to be offered for free or at a substantially lower cost. Among those that stand to benefit are the new crop of entrepreneurs and gig workers that have come to characterise the evolving demographics of employment across the globe.

SME Working Capital Loans & SME Fixed Assets Loans

SMEs by their nature are risky endeavours and as such are often viewed with caution by investors and banks looking through loan applications. Funding is consequently sorely lacking and expensive. A typical complaint of SMEs is prohibitively costly SME working capital loans from traditional banks and that even government productivity schemes with subsidised SME fixed assets loans are not attainable across the board. Statistics from the World Bank highlight that 40% of SMEs in developing countries are unable to meet a financing need which equates to a potential market worth US$5.2 trillion annually.

Digital banks are able to tap on non-traditional sources of funding such as peer-to-peer lending to provide financing to SMEs. Temasek Holdings, Singapore’s sovereign wealth investment firm even backed lending platforms by throwing its weight behind Validus, a peer-to-peer lending platform looking to expand into Singapore.

For start-ups, just the partnerships with large local corporations like these contribute value by providing its clients with an association to these blue-chip entities which is seen as a strong vote of confidence. The benefits extend beyond an elite association too, as expertise in running a business is transmitted through loan conditions.

Traditionally, banks determine their loan offers to SMEs based on risk metrics. The usual toolkit consists of collateral, guarantor or cash flow pledging, amongst other types of surety. Digital banks do not give away money carelessly, nor are they exempt from industry regulations but once again utilise technology to assess the creditworthiness of a potential client. Big data provides a more accurate picture as opposed to time worn methods that overburdens clients. In keeping with this direction, digital credibility is being explored as an alternative method of pricing and granting loans. Similar to the mechanics of rating vendors on apps like Grab, Ebay and Carousell, statistics such as service scores, number of bad reviews, social media activity can be harnessed to form a clearer profile of potential clients.

The Future or Fad?

As with the first movers in any new industry, it may seem that these new challengers are the only ones moving forward. It would be short-sighted to assume that conventional banks are standing still in the face of disruptive competition. All modern banks have been forced to take their operations online and to emulate the client orientated focus of their digital rivals.

Regulators are also keeping an eye on the new breed of digital banks which have an as-yet untested business model and face greater business and security risks due to the lack of personal interaction with clients. Regulatory restrictions will eventually converge for both, narrowing any advantage one has over another.

A true picture of the sustainability of digital banks is obscured by fervent funding at the moment which sustains their operations in this growth phase where the bottomline still remains in the red. As this segment matures, a more level playing field will emerge. A natural progression of digital banks would also naturally gravitate towards providing a stronger customer connection that goes beyond savings on fees. Otherwise, they will be stuck serving only the niche sectors that they currently thrive in.

The move to greater digital presence is unavoidable and the future of banking most likely sees an aggregation of both business models. Traditional retail banks that lack a digital presence would have to duplicate the business model or merge with existing digital banks to acquire this capability. This is a desirable outcome to for digital banks as investors start to demand a return on their seed money or when they seek to grow beyond the niche markets that they currently serve. On one hand retail banks have the financial experience but lack the mobility and technological expertise while on the other there is a Fintech firm with a ready-made turnkey solution without an established client base – sounds like a match made in heaven to me.

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