Interest in digital bank licences high; applicants see opportunity as local banks extend their lead

On Jan 7, the Monetary Authority of Singapore (MAS) announced that it had received seven applications for the two digital full bank (DFB) licences on offer, and 14 applications for the three digital wholesale bank (DWB) licences. MAS says the new digital bank licences attracted strong interest from a diverse group of applicants which include e-commerce firms, technology and telecommunications companies, FinTechs (such as crowd-funding platforms and payment services providers) and financial institutions. “The majority of applicants are consortiums, with entities seeking to combine their individual strengths to enhance the digital bank’s value proposition,” MAS adds.

The applicants themselves have expressed confidence their consortiums have what it takes to reach out to millennials and the underserved. Razer Fintech, a unit of Hong Kong Exchange-listed Razer, announced it plans to establish Razer Youth Bank with a consortium (see table) if it is successful in its DFB application. Razer Fintech claims it has a “deep understanding of the lifestyle needs of the youths and millennials and be able to customise relevant products and services”.

Grab and Singapore Telecommunications (Singtel) is a consortium that market watchers reckon have a good shot at winning. A Grab spokeswoman says that Grab has learned there is potential in tapping the unbanked and underbanked in Southeast Asia following the introduction of its GrabPay wallet in 2016 and the launch of Grab Financial Group in 2018.

“Digital banks or virtual banks offer an opportunity to build a mobile-only platform offering deposits, loans, asset management and insurance that is well regulated for consumer protection, without being constrained by the need to establish a large physical branch network. This could allow the digital bank to quickly scale its delivery of financial services to underserved consumer segments in the region. It will also drive more competition and investment into technology among conventional financial institutions, which will ultimately benefit end-consumers,” a Grab spokeswoman says.

In general, all the known applicants have claimed they would focus on previously underbanked segments in Singapore including millennials, start-ups and micro-SMEs.

Challenges ahead for applicants

For DFB licences, MAS will only consider applicants who are anchored in Singapore, controlled by Singaporeans and headquartered in Singapore. Locally incorporated banks, which will include the DFBs, have to comply with certain regulations. Although they will not be G-Sibs, or global systemically important banks, as defined by the Basel Committee on Banking Supervision, the new DFBs are required to follow the same regulations local banks comply with.

For instance, banks have to disclose 12 indicators based on cross-jurisdictional activity, size, interconnectedness, substitutability/ financial institution infrastructure and complexity on an annual basis, in accordance with instructions issued by the BCBS.

The minimum common equity tier 1 (CET1), tier 1 and capital adequacy ratios (CAR) set by MAS as at Jan 1, 2019, under MAS Notice 637 are 9.0%, 10.5% and 12.5% respectively, and viewed as higher than those in other developed-market jurisdictions. The three local banks have CET1 ratios of 13.5% and above.

DFBs have to comply with liquidity ratios set out in various MAS Notices such as MAS Notice 649 and 653. Liquidity coverage ratios (LCR), net stable funding ratios (NSFRs) and leverage ratios are regularly disclosed by the local banks.

The LCR requirement is to ensure that domestic systemically important banks have sufficient unencumbered high-quality liquid assets (HQLA) to survive a significant stress scenario for the next 30 days. The minimum regulatory requirement for Singapore dollar LCR is 100%, and those of the local banks are comfortably above this threshold.

The NSFR aims to limit banks reliance on short-term wholesale funding and seeks to ensure that banks maintain a stable funding structure. Another aim is for the NSFR to ensure that funding shocks do not significantly increase the probability of distress for individual banks.

The minimum leverage ratio set by MAS is 3%, and those of the three local banks are well above 6.5%.

DFB and DWB applicants need to meet certain eligibility criteria. At least one entity in the applicant group must have three or more years of track record in operating an existing business in the technology or e-commerce field. Key persons must be fit and proper. The applicant must also meet certain minimum paidup capital requirements, provide a clear value proposition, demonstrate a sustainable business model and submit a plan for an orderly exit, MAS says.

If eligible, the DFB and DWB applicants will be assessed on their business model and their ability to manage a prudent and sustainable digital banking business. This includes the level of understanding of key risks in a banking business, and growth prospects and other contributions to Singapore’s financial centre.

Local banks forge ahead digitally

The biggest hurdle is that the local banks themselves have raised their game. Both DBS Group Holdings and United Overseas Bank have digital banks of their own which are operational.

DBS launched digibank in India in 2016 and in Indonesia in 2017. In a media briefing on Jan 9, Piyush Gupta, CEO of DBS, reveals that DBS has 600,000 digibank customers in Indonesia.

“When we acquired Australia and New Zealand Bank’s retail business, it allowed us to build retail, wealth management and corporate businesses, and roll out credit cards and internet banking. We launched digibank and we have 600,000 clients in our digibank offering,” Gupta says. “Regulation has been quite favourable. We’ve been able to use facial recognition to open accounts.”

In Indonesia, DBS has started algorithmic lending. “We’ve been doing algorithmic lending for 12 to 18 months, and non-performing loan ratios are very [low]. Most of our lending [in developed markets] use credit bureaus. In Indonesia the number of people who have a bureau record is low. You need to find proxies to bureau scores and this would expand the market. Our experience has been quite good. We learnt in Indonesia and we’re transferring back [the learnings] to India,” Gupta explains.

UOB launched TMRW in Thailand in Feb

2019. In Dec 2019, TMRW enabled fingerprint and facial biometrics to make it speedier and safer for customers to open their TMRW accounts.

The opportunity

Maybank Kim Eng, in a research report dated Jan 7, reckons that success in winning the licences, and subsequent operational success may likely be determined by the depth, quality and access to data the consortium will have. “Data will be the key driver that can help lower transaction costs and manage risks effectively in customer segments that traditional banks have historically shunned as unprofitable,” says Thilan Wickramasinghe, an analyst at Maybank Kim Eng.

“Digital banks are uniquely geared towards solving this problem as they are unburdened from historical infrastructure costs. They can achieve this through automating onboarding, Know Your Client, underwriting, monitoring and risk management using big data, artificial intelligence analytics, machine learning etc., on their virtual platforms,” Wickramasinghe says.

The cost of approving a SME loan by MyBank, which is 30% owned by Ant Financial Services Group, is around RMB2 compared to RMB2,000 for a traditional bank. Since launching, MyBank has been able to extend credit to over 7 million customers, using their Big Data and AI-driven algorithms.

Cybersecurity could be a challenge

Meanwhile, cybersecurity issues have emerged among the contenders. One of the unconfirmed contenders for a DWB, ByteDance Technologies, owns TikTok. Check Point Research, the Threat Intelligence arm of Check Point Software Technologies, announced on Jan 8 it had found several vulnerabilities in the TikTok application. These vulnerabilities could have open up the content of user accounts to manipulation by attackers. These include uploading of unauthorised videos, deleting of videos, or making private videos public. It is also possible to extract confidential personal information saved on these accounts.

Tim Mackey, Principal Security Strategist at Synopsys Software Integrity Group, says that there could be more areas that could be under attack by hackers. “Developers [such as Check Point] performing this research would likely have identified not only the specific attack method, but could likely have discovered additional potential areas for user data to become compromised. Developers tend to repeat coding patterns and if a given coding pattern leads to security issue under one condition, it likely leads to security issues when used elsewhere in the application,” he says.

According to a Reuters report in November last year, the US government launched a national security review of ByteDance’s US$1 billion ($1.35 billion) acquisition of US social media app Musical.ly. Furthermore, according to USA Today, the US Navy banned the use of the application for its personnel and CNet.com reported that the US Army banned TikTok from use on government phones, reversing its policy on the entertainment app, which it recently used as a recruiting tool. TikTok — an entertainment app — has around a billion users.

Digital banks largely loss-making

Shareholders of the five new Singapore digital banks will need deep pockets. Despite the use of technology for machine learning, AI and enhanced risk management tools, non-performing loans appear inevitable for most digital banks.

WeBank — which uses data from its sister company WeChat — reports NPL ratios of around 0.64% compared to the national average of 1.89%, the Maybank Kim Eng report points out.

In December, according to the UK’s Sunday Times, OakNorth Bank suffered its first defaults from two property- backed loans. The virtual bank is now looking to offload chunks of five or six of its largest loans in order to reduce its exposure. OakNorth is the first virtual bank in the UK to turn in a profit in FY2018.

In its FY2019 annual report for the 12 months to Feb 28, 2019, Monzo, another UK-based digital-only bank, said its total Expected Credit Loss (ECL) on lending for 2019 was GBP3.1 million. During FY2019, the year, Monzo recognised an ECL of GBP773,000 against a receivable balance related to a closed prepaid card programme and it announced a credit impairment charge on overdrafts and overdrawn balances of GBP3.084 million. Most of Monzo’s loans are overdrafts. Monzo made a net loss of GBP47.16 million in FY2019. Atom Bank, another UK-based virtual bank, reported a net loss of more the GBP80 million for the FY2019 ended March 31, 2019.

Despite their losses, the British banks are useful as experiences. For instance, Atom Bank started operations in 2015, and in 2018, its loan book increased 12 times y-o-y. Monzo which also started in 2015, saw its loan book increase by seven times in its third year, or 2018.

DFBs could account for 0.8% loans by third year

Maybank Kim Eng’s Wikramasinghe calculates that if the local DFBs follow the path of Atom and Monzo, they will account for $2 billion of loans by Year 3 — this is 0.8% of Singapore dollar system consumer loans as of end November 2019.

For DWB, Wikramasinghe assumes that some of the funding could be from the interbank market rather than just from deposits. Hence DWBs could be more aggressive in loan growth. Even then, Wikramasinghe calculates that the three DWBs will account for $6.2 billion of loans or 1.5% of business loans as at end Nov 2019.

Hence, Maybank Kim Eng reckons that the impact on the local banks is likely to be limited in the next three years, assuming the incumbents sit still in the face of competition.

But the local banks are not sitting still. Instead, they continue to forge ahead. UOB is likely to announce the launch of TMRW in a second market soon. In an earlier interview, when asked if the new digital banks would be a threat, Dennis Khoo, regional head of TMRW Digital Group, replied that by the time the new banks are operational, TMRW would probably be in its third market as UOB’s plan is to build an Asean digital bank.

Last year, DBS’s digibank already expanded into its third market, Hong Kong.