Regulatory caps on neobanks’ operations could stifle growth, expert warns

Despite questions arising from the recent rise of deposit caps in neobanks, incumbent banks are left unfazed.

Singapore’s banking sector has witnessed a recent adjustment in deposit caps for digital start-up banks, raising questions about how this change will affect the profitability and market dynamics within the industry. 

“Would that impact the incumbent banks? Informally speaking, this is a drop in the ocean compared to their deposit base. I wouldn’t say, just from a numbers perspective, it has a big impact,” said Justin Tan, partner and regional head of Financial Services Practice at Arthur D. Little, in a recent interview with Asian Banking and Finance.

“I think what you will see, though, is that as the cap is raised potentially for the digital full banks (DFB), yes, it is a big deal to them. So, they are able then to scale their business model,” Tan continued.

Fitch Ratings has examined this development and suggests that whilst it may have some implications for emerging digital banks, it is unlikely to significantly dent the profitability of the country’s dominant incumbent banks.

“The small size of digital bank deposits relative to those of the three largest local banks suggests near-term implications for competition and net interest margins (NIMs) will not be significant,” Fitch Ratings said in a report.

Singapore’s banking landscape is predominantly shaped by three major local banks: DBS Group Holdings, Oversea-Chinese Banking Corporation (OCBC), and United Overseas Bank (UOB), collectively holding a substantial 65% share of all Singapore-dollar deposits.

In stark contrast, the digital banks, GXS Bank and MariBank, find themselves operating within a capped deposit limit of S$100m. Both neobanks hold a banking licence issued by the Monetary Authority of Singapore (MAS). 

Mid-2023, GXS and MariBank — two digital full bank licence holders — raised their individual savings account cap to S$75,000, indicating that the S$50m cap on aggregate deposits for each digital bank may have been lifted by regulators.

Whilst digital banks may see a substantial rise in their deposit holdings, as observed with Trust Bank, Fitch believes it would not significantly impact competition dynamics in the next few years. The higher savings account caps align with Singapore’s existing deposit insurance limit, offering depositors protection.

However, Fitch points out that digital banks could face challenges beyond funding.

“These include attaining sufficient scale to achieve profitability, gaining access to bankable customers and asset origination opportunities, and developing a range of products that are priced competitively after adjustment for the relevant credit risks,” Fitch added.

On the other hand, the central bank has kept this regulatory criterion in its back pocket but has not publicly announced it. “MAS has long planned to increase and eventually remove the cap as banks meet certain regulatory criteria, and the two banks had pushed for the cap to be raised in recent weeks,” Fitch said.

The sheer disparity in deposit size between these two categories underscores the enormous gap that exists in the Singaporean banking sector.

In the neo

The Singaporean central bank initially imposed a S$50m cap on retail deposit bases for DFB licences during their first two years of operation. During the progression period, a DFB’s aggregate cap is expected to steadily increase.

However, wholesale deposits are not included in the aggregate deposit cap if the restricted DFB has a minimum paid-up capital of S$100m.

Whilst intended to ensure a cautious approach and prevent potential mishaps, this cap has proved restrictive for the growth of DFBs. In some cases, these banks reached their cap within the initial months of operation.

Consequently, digital banks are actively lobbying for an increase in the cap.

In terms of the incumbent banks, the increased deposit cap for digital banks may seem like a minor perturbation.  The dominant banks boast deposits exceeding S$500b, dwarfing the capped limits of the digital newcomers.

Beyond regulatory constraints, digital banks face the formidable challenge of establishing trust, a vital asset in the banking industry. Incumbent banks have a tangible presence and a well-established track record, making it easier for customers to trust them.

“Beyond the regulatory constraints that we have mentioned, I do think the digital banks still need to overcome the relative weakness in terms of trust. Compared to the incumbents, they are known brands — you can see them, you can feel them,” Tan said. “For the digital banks, beyond being digitally savvy, their customer base is skeptical – which they need to cross.”

To overcome this hurdle and expand their customer base, digital banks must focus on innovative products and services. By starting with niche products and progressively scaling these offerings, digital banks can gain the trust and acceptance of a broader customer base, setting the stage for future growth.

Along the horizon

Looking ahead, the impact of deposit caps on digital banks is dependent on regulation. Initially, deposit caps serve as a safeguard, creating a controlled environment for testing processes and customer engagement.

However, if the goal is to nurture a thriving digital banking industry, these caps must evolve in tandem with the sector’s growth.

In the worst-case scenario, some digital banks might be forced out of business due to an inability to achieve the necessary scale to cover their operational costs.

Alternatively, incumbent banks might acquire struggling digital banks for their technology and customer base, further consolidating their dominance.

“If the caps are not relaxed, over the longer term, then the digital banks will remain quite niche and specialised. In my view, the caps play a role in the initial phase when you launch the banks – and almost in a sandbox kind of environment – because you're trying to test out their processes, that engagement, your customers to make sure nothing goes wrong. So it's a nice lab environment.” Tan said.