Virtual banks unlikely to threaten incumbent ASEAN banks: Fitch

Their digital edge, branchless model, and cost-efficiency plans give little edge against established lenders.

The entrance of virtual-only banks in Southeast Asia could put pressure on established banks’ profitability, according to Fitch Ratings. However, the report also assured that it is unlikely to pose a large threat to the digitally-advanced incumbents, at least in the near term.

The economic fallout resulting from the pandemic has dented the neobanks’ target segments more significantly, which reduced opportunities for a profitable business.

It has also forced incumbents to accelerate their digitalisation journey, which potentially diminished the neobanks’ cost advantage over traditional banks.

“Existing neobanks' business models and risk controls are largely untested over the course of economic cycles, and the coronavirus pandemic is likely to hit their main target segments—the underserved and unbanked—disproportionately, potentially forcing some to revisit or refine their strategy,” Fitch Ratings analysts Tamma Febrian, Gary Hannify, and Parson Singha wrote on their report.

Meanwhile, the branchless operating model often touted by digital-only banks presents little edge over traditional banks in an urban setting and will only be pronounced when targeting underserved or rural settings.

Lenders in developed markets such as Singapore have generally not been relying on expansion of physical distribution channels to drive revenue in the past few years.

Further, bank branches in large or first-tier cities have already moved on from being transaction points to customer sales touchpoints, according to Fitch.

The cost efficiency of challenger banks, or their operating expenses and average assets, is also not always better than ASEAN’s incumbent banks. A notable exception is South Korea’s KakaoBank, which is 1.5x more productive than traditional lenders in the Philippines, Vietnam, Indonesia, and Thailand.

In contrast China’s WeBank is faring worse than select lenders in Vietnam, Philippines, Thailand, and Malaysia, with a higher proportion of impairment cost and operating expenses compared to banks in these markets.

“WeBank's higher credit costs (2.2% of assets in 2019) relative to many banks in the region suggest that the effectiveness of its alternative risk modelling may be bound to the inherently higher credit risk of their borrowers,” the analysts added.

Winning aspirants
Amongst aspirants, large technology players and digital banks that are backed by established corporates—as opposed to standalone neobanks—are as most likely to secure digital bank licences and compete more formidably against incumbents in the medium term, they added. This is due to their strong brand recognition, extensive customer base and established technology platforms.

“By leveraging advanced data analytics on extensive customer bases, big tech companies could potentially offer loans to their target markets in a swift and highly scalable manner without the overheads associated with operating a physical branch network,” the analysts noted.

Amongst those named include Alibaba, Tencent, Google, and Ant Financial, for example. In particular, Ant Financial—which  was reportedly applying for a wholesale bank licence in  Singapore without forming a consortium—may seem like a relatively new player in SEA but is backed by Alibaba, owner of Lazada and Taobao,  two of the most established e-commerce platforms in the region.

However, many incumbents in the region have also invested heavily into their digital capabilities, with some already running as efficiently as some neobanks.

Regulatory hurdles are also likely to constrain aggressive competition, which will limit pressures on incumbents' business volumes and profitability.

Markets with potential
Meanwhile, amongst markets, Philippines and Indonesia present the largest untapped potential. This is on the back of their large unbanked populations, relatively low household leverage and sizeable economies.

Indonesia, in particular, has a booming peer-to-peer (P2P) lending segment, with around 161 players as of end-May from just 88 at December 2018. Their collective outstanding loan balances have also grown rapidly to $1b as of May, although it only accounts for 0.3% of Indonesia’s banking system loans, noted Fitch. These all indicate that investors are bullish on Indonesia’s market potential.

In comparison, Singapore is a lot more well-banked and has little space for new banks to establish a foothold. However, it also has a favorable business environment, and the Monetary Authority of Singapore’s (MAS) high regulator bar acts as a de fact certification process guaranteeing neobanks’ credibility and franchise.

Singapore also needs in terms of digital infrastructure readiness amongst ASEAN peers with its high smartphone penetration rate, national digital data ID repository introduced in 2016. Both Indonesia and the Philippines lack these.

Malaysia is also noted to have attracted significant interest for its virtual bank licenses. But Malaysia, like Thailand, has a highly leveraged household sector which constraints the growth potential of digital-only banks.

Only Singapore and Malaysia have so far announced regulatory guidelines on virtual banks. In both markets, the virtual banks are generally subjected to slightly more lenient capital and liquidity requirements than incumbents during the foundational phase, which can last up to five years, the report noted.

However, regulators have emphasized the overarching need for business sustainability, with aspirants needing to submit a comprehensive business plan that shows path to profitability.