The future of digital banking
'Digital' has become one of the most commonly used words these days. Everything now has the precursor 'digital' attached to it, and digital banking is no exception. With the advent of Covid19, articles claiming a "digital financial revolution" and Pakistan's sleeping commercial banking sector turning the corner were seen in abundance.
Unfortunately, the reality is far from these rosy pictures being portrayed. While there has certainly been increased activity in digital payments and additions to new customer acquisition, it is not clear if this was a result of the temporary elimination of fees on interbank funds transfer or a structural change in customer behaviour.
For a digital financial revolution to happen in Pakistan, millions of people will need to change their behaviour. They will only do so if it's to their benefit. The customer journey, the banks' desire for innovation, the use-cases available for using a mobile wallet as well as the commercial banks' dependence on income from government instruments, will all have to change.
Financial revolutions don't happen because it's easier to open a bank account. That is useful but simply the first step. It has already been established that Pakistan has one of the easiest account opening processes, based on the bulk of its population being bio-metrically verified and this data is available in real-time online. Let us peel the onion to really determine what is required to make digital financial services successful in Pakistan.
The ground reality is that most commercial banks in Pakistan operate like asset management companies The definition of digital banking is simply the provision of service over the internet or through a digital medium. An example would be to transfer money to a mobile wallet as opposed to giving a cheque or cash or using an app to pay your utility bill as opposed to physically with cash. The real end result has to be a change in the customer journey. The customer must find the use of the digital medium convenient, secure and transparent but not necessarily less expensive. Let us explore the myths being perpetuated and the ground reality.
The first myth is that if the State Bank of Pakistan (SBP) was to create a new category i.e. a digital bank license, a digital revolution would occur. Let us review the fate of the most acclaimed digital banks: Revolut, Europe's $5.5 billion digital bank just reported that their losses tripled in 2019. Manzo, another much-touted digital bank announced their losses doubled, and lastly Starling, another darling of the digital industry made a loss in 2019. All these banks have been operational for over five years.
Their monetisation is largely dependent on payments and, in some cases, savings accounts. In Pakistan, the payment services can be replicated by obtaining an EMI (electronic money institution) license. A lending license can be obtained through either the State Bank of Pakistan or the Securities and Exchange Commission of Pakistan. Therefore, it certainly cannot be concluded that the magic wand (digital bank license) would cause a digital financial revolution.
The second myth is that, with the increased payment transaction volume in the past six months, commercial banks will now lead the digital financial revolution. To evaluate the veracity of this claim, we need to examine the earning 'DNA' of the banks, the composition of their boards and the existence - if any - in the banks CEOs' performance indicators, for improvement in either the customer journey or the earnings from new digital activities.
The ground reality is that most commercial banks in Pakistan have activities akin to an asset management fund as opposed to a bank.
The most profitable banks in Pakistan are heavily dependent on the interest rate arbitrage available between their cheap cost of funds and risk-free investment in government securities (Treasury Bills and Pakistan Investment Bonds). Commercial banks have little risk appetite for consumer or micro-lending. In fact, their total number of individual customers in a country of circa 220 million people is less than two million.
The notion that commercial bank branches will disappear due to digital progress flies against the realities of these branches being sources of cheap deposits. In fact, it is very possible that commercial banks will continue to grow their physical footprint in order to protect their interest arbitrage 'gravy train'.