The banking regulators of Singapore and Hong Kong, the Monetary Authority of Singapore (MAS) and the Hong Kong Monetary Authority (HKMA) decided more than a year back to licence standalone virtual banks. Singapore is ready to licence two full virtual banks and three wholesale virtual banks.
Hong Kong’s MA has already gone ahead and licenced eight virtual banks from a pool of more than 30 applicants. “The new digital bank licences mark the next chapter in Singapore’s banking liberalisation journey,” Tharman Shanmugaratnam, head of the Monetary Authority of Singapore, had said in a statement.
Singapore and Hong Kong are highly banked regions with close to 95 percent of the population in both regions having access to banking services. And the traditional banks in the region have deeply entrenched operations with a stranglehold over the banking market while enjoying high levels of customer trust. In addition, these traditional banks have enabled a fairly high level of digitalisation compared to their peers in the region.
HSBC, for example, claims that it is already a digital bank with 90 percent of transactions happening digitally in Hong Kong. So, in these highly advanced and banked markets, is there space for standalone virtual banks? What are the make and break factors that will determine the success or failure of virtual banks? And which jurisdiction among Hong Kong and Singapore is likely to see virtual banking success in five years?
Banking the underserved and unhappily served
Razer, basically a digital gaming hardware company that has achieved success with a payments app in Southeast Asia, is one of the companies interested in applying for a virtual banking licence in Singapore. As soon as Singapore’s MAS announced its decision on virtual banking licences, Razer’s chief strategy officer Lee Limeng had said in a statement that the company would ‘definitely consider’ applying for a virtual banking licence in Singapore. Razer told International Finance that the company had no further comments on the matter at this moment.
In July, Reuters reported that Grab, a Southeast Asian unicorn that started off primarily as a ride-hailing company, was gearing up to apply for a virtual bank licence. A virtual banking licence in Singapore could help Grab to benefit from its data on mobility metrics, payment transactions, and consumer behaviour.
The entry of Razer and Grab, which are companies with large existing customer bases, could shake up Singapore’s banking sector so far dominated by DBS Group, Overseas-Chinese Banking Corp, and United Overseas Bank. With a banked population of close to 96 percent, which is the demographic that fintechs like Grab and Razer are targeting at? What is the differentiated value proposition that they are trying to deliver?
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Grab first created its mobile wallet GrabPay to meet the challenges of cash in Southeast Asia. While SMEs contribute more than 50 percent of Asean’s GDP, two-thirds of SMEs cite business funding and financing as their biggest problem. Grab claims to have served more than nine million micro-entrepreneurs over the last six years.
It expects to leverage scale and data insights to bring financial services products to market at a more competitive price point than anyone else. With its Grab SuperApp, the fintech already provides a wide range of earnings and financial security opportunities for entrepreneurs in Southeast Asia. It presents a formidable challenger bank contender for the existing banks, sitting on a data goldmine.
Singapore’s 2018 SME Development Survey showed that 50 percent of Singapore SMEs face financial challenges in managing cash flow, liquidity, and credit risk, up from 38 per cent in 2017. SMEs make up close to one-third of all companies in Singapore. Regionally, more than half of all micro-enterprises and SMEs in southeast Asia faced a financing gap of about $175 billion, according to McKinsey.
Singapore’s Business Times had reported early this month that OCBC is engaged in discussions with Keppel Corporation, peer-to-peer lender fintech startup Validus, and venture-capital fund Vertex Ventures to form a digital-bank consortium.
The major banks in Singapore are risk-averse in lending to SMEs, especially those that do not have a track record of operating for more than three years. These SMEs typically address their financing gaps through financing through family and friends, angel investors, and peer to peer lenders. The virtual banks are expected to address the needs of these segments using technology and also to potentially nudge the incumbent banks to examine how to serve these small businesses.
Validus itself is a good example of a fintech reaching out to the underserved SME segment of Singapore. The P2P lender works with a number of large enterprises in Singapore to match the group of small vendors and contractors that have contracts with the large companies with financing. It is in the interest of the large enterprises to ensure that their small enterprise vendors are sufficiently financed.
Validus uses the risk profile of the large corporates to finance the SMEs at a lower cost. Validus said in the press release that it had facilitated over 5,000 loan facilities, amounting to nearly S$250 million (US$184.4 million) in growth financing to Singapore’s SMEs without needing to pledge hard collateral.
Since 2015, Validus has disbursed an average of S$20 million (US$14.8 million) per month and claims to have brought down the financing costs for SMEs by almost 80 percent as compared to other sources. A Validus spokesperson told International Finance that the company is reserving comments on the virtual banking licence for the moment.
Behind the Singapore government’s decision to licence three wholesale banks focused on SME lending is the need to digitise SME services and to increase SME productivity. A lot of SME services are not digitised while at the same time, the SMEs are getting digitised to a certain extent. Services such as invoice discounting or getting a letter of credit are not fully digitised in Singapore and Hong Kong.
Singapore has a major government programme called SME Go Digital, with a focus to increase the productivity of SMEs through digitisation. “This means that the financial services aspect of the SMEs must also be digitised. Which includes digitising their payrolls, expense management, claims management, and the reconciliation of their accounts payable and receivable to bring efficiency in all these areas,” Varun Mittal, Ernst & Young’s Global Emerging Markets FinTech Lead told International Finance.
“The overall aim is to make SMEs more efficient. Hence, the focus is to build financial institutions that can serve these types of digital-native businesses and customers. The premise is that since these niche financial institutions do not have legacy technology, they can leapfrog certain process steps, focus on innovation, and drive financial inclusion through innovation,” adds Mittal.
The three virtual wholesale bank licencees cannot take deposits from individuals except in the case of fixed deposits of at least SG$250,000 but they will maintain business deposit accounts for SMEs and other businesses. Although capital and liquidity rules or the wholesale virtual banks are the same as existing wholesale banks, and they are mandated to keep a minimum paid-up capital of SG$100 million.
” Mobile penetration is extremely high in Singapore at 144 percent and 22 percent of the population is made up of millennials. According to an Ipsos survey, 48 percent of Singapore millennials who regularly check their bank account do so through mobile phone. There is possibly another segment of the Singapore banking market who are not adequately supported by the incumbent banks – who can be called the ‘unhappily served’ segment of the population.
For example, according to a survey published by Blackrock early this year, 90 percent of Singapore millennials said that they were overwhelmed by the sheer number of investment options available while 77 percent found investing too hard to understand due to the “lack of clear and user-friendly information.” Today’s customers want banks to empower them with the right financial decisions. But are banks doing it? Probably not.
“The core function of a bank is threefold. First, to safeguard the customer’s assets. Second, to enable their lives – such as helping them make payments or lending money. Third, to help them build their wealth. Today with regard to the third aspect, there is an emerging sense from customers that banks have moved to selling products, rather than empowering them,” Harjeet Baura, Partner and Asia Pacific Digital Banking Leader, PwC Hong Kong told International Finance. How do banks use technology to nudge customers and help them make smarter decisions? This is the function the traditional bank relationship manager used to do for customers.
“When you approach that problem from a tech mentality you look at that problem very differently compared to a bank and that is where real innovation begins. Banks in the region can do that because they still retain customer trust, unlike say, the UK banks after the crisis. But customers are not receiving that education and empowerment that they are expecting from traditional banks and many feel that they are being sold to,” adds Baura. This is one aspect in which virtual banks can bring a differentiated value proposition.
Another value proposition is convenience. An ecommerce company understands its customer’s behaviour, account, and how much the customer is selling to give a loan on the basis of the records it has. The value proposition of a virtual bank run by an ecommerce company is that the customer need not present further documents for financial services. “A ride-hailing company might be able to give a driver a loan to buy a car because it knows when, where, and how of the way he operates and issues the loan without further documentation. These kinds of user experiences can drive people towards virtual banks run by the technology companies,” says Varun Mittal of EY
Hong Kong – targeting the mobile banking underbanked
On the surface, Hong Kong might seem to have similar dynamics to Singapore in the sense that 96 percent of the population in Hong Kong is banked. But there’s a major difference – according to a JD Power survey, Hong Kong is significantly underbanked as far as mobile banking is concerned – only 30 percent of Hong Kongers interacted with their banks through mobile phones compared to 41percent in Singapore and 78 percent in China.
Also, according to the same survey, close to one-third of Hong Kongers are considering switching their main bank account compared to around one-fifth of Singaporeans. In Hong Kong, the licenced banks control virtually 99.3 percent of total loans. Among the licenced banks, Standard Chartered, Bank of China (HK Holdings), and HSBC (with unit Hang Seng Bank), — control two-third of retail banking and three-fourths of mortgages and credit cards. So, is there space for eight virtual banks?
A spokesperson for SC Digital told International Finance that the fact that Hong Kong is underbanked as far as mobile banking is concerned and also the fact that online services of traditional banks are just digitalised versions of traditional services is the reason that they believe that virtual banks can make inroads into the Hong Kong banking market with niche products.
“We will be bringing together a new brand, a new technology stack, and a whole new customer experience that will be cloud-based and service-led, leveraging on our unique partner ecosystem, including with PCCW, HKT and CTrip.com to deliver a differentiated banking experience for customers,” the SC Digital spokesperson told International Finance. We will update the market with more details of our products and services closer to launch,” the spokesperson added.
One of HKMA’s key goals for licencing virtual banks is to promote financial inclusion for target retail segments and SMEs. Of the eight licenced virtual banks in Hong Kong at least four have an explicit SME financing focus. Standard Chartered and Bank of China (Hong Kong) are among the eight virtual bank licencees in the city.
The others are ZhongAn Online, WeLab, Ping An OneConnect, a unit of Ping An Insurance Group, Ant Financial Services’ subsidiary Ant SME Services, a Xiaomi-AMTD Group venture named Insight fintech, and the Fusion Bank consortium — including Tencent Holdings, ICBC (Asia), and Hong Kong Exchanges and Clearing Limited (HKEX).
” Ant SME the virtual bank of Chinese fintech giant Ant Financial and Ping An OneConnect the virtual bank of Chinese financial conglomerate Ping An are going solo for their virtual banks. At the same time, SC Digital is a consortium between Standard Chartered, telecom majors PCCW and HKT and leading Chinese online travel company CTrip.
Chinese internet giant Tencent has won a virtual banking licence in a consortium. The impact the virtual banks are trying to make is on customer experience and the effect of the competition is already visible in the recent actions of the traditional banks who have mostly done away with or reduced minimum balance fees in Hong Kong. Virtual banks are not allowed to charge anything for low balance.
Carmen Lee, a spokesperson for Tencent, told International Finance that with regard to Fusion Bank, the consortium’s digital bank, the focus is on delivering a better banking customer experience through the use of technology. “As a virtual bank based in Hong Kong, local customers are Fusion’s primary target users as we hope to promote financial inclusion in Hong Kong. We also aspire to understand customer needs better, deliver solutions at a more cost-efficient manner, and adapt to evolving market changes quicker. Fusion is now in the preparatory stage and we are hoping to gradually put (it) into service as soon as possible,” Lee added.
Does the consortium model provide a workable model for running a virtual bank or is going solo better? “This consortium model shows how potentially powerful such partnerships can be and how they can offer services that traditional banks are not able to deliver. In addition to quickly achieving scale, partnerships also help to bring a differentiated value proposition to the market. The winners are going to be the virtual banks that bring a differentiated proposition to the market quickly – different to the way banks operate today in Hong Kong and across the region,” said Harjeet Baura of PwC Hong Kong.
Millennials have active lifestyles and they seek curated lifestyle experiences, so bank in partnership with a travel company can get involved in the end-to-end customer journey with regard to travel. The involvement can be from the moment they start planning to save for the holiday right to providing the financing for the trip and to the travel experience, the ability to pay for shopping and the transactions overseas, in the same manner, a credit card distribution bank would be doing today. In this regard, the SC Digital spokesperson told International Finance, “Leveraging available technology, we can provide products and services that are more contextual and personalised to customers.”
What makes a virtual bank successful?
Virtual banks that have attained profitability have done so by growing personal loans massively. The key make or break factors for virtual banks include achieving scale in terms of customers, lowering operating costs over time, and getting the business model right. According to Varun Mittal of EY, for digital banks, one make or break factor is whether the virtual bank can become the primary bank of its customers.
“The measures for success would be the share of wallet a virtual bank has, or the share of services that it has, the percentage of loans it gives, the insurance it sells, and the share of wealth management it does. If a virtual bank’s customers are mostly secondary accounts, the question is how can the bank be the best secondary account possible as well as how the bank can build a sustainable business out of it,” he adds.
The winners are going to be the virtual banks that bring a differentiated proposition to the market quickly. And it is also about the digital banks being able to integrate the differentiated proposition into how people live their lives, says Harjeet Baura. Integrating financial services and payments into a chat platform is a great example of such integration. Baura cites the example of Russian digital bank Tinkoff which is public about the fact that it wants customers to visit its app ten times a day. Today, banks have to be on the same real estate the customer lives his life.
“Customers do not check their bank balance ten times a day, but they do live their lives on many apps and platforms – people check their chat messages with friends many times a day and they may also pay money to buy coffee and other daily goods and services many times a day through a payment app. And when you build a platform where people come in ten times a day and you enable their lives through financial services and payments on top of that, you have a great business model,” adds Baura.
Kakao Bank of South Korea, one of the few, if any, profitable virtual banks in the world, is a clear example. Launched in mid-2017, by September 2019, Kakao had over 10.69 million customers with total deposits at 19.9 trillion won ($1.7 billion) and lending at 13.6 trillion won ($1.1 billion). It made a profit of 15.3 billion won or $13.1 million in the first nine months of 2019. Kakao Bank was built off South Korea’s highly popular messaging platform, Kakao Talk.
60 percent of the Korean traditional banks costs come from branch operations. With mobile-only operations, Kakao reduced overseas remittance commissions to one tenth of existing banks and offered much better prices for deposits and loans. What’s more, it cut in half the number of steps customers need to take to open accounts and access financial services, bringing real convenience.
Fact is with virtual banks, top-class customer experience is a given expectation. Where virtual banks can make a difference is in offering differentiated products with convenience. The long-term success of the virtual banks depend upon differentiated products – technology is just an enabler. The virtual bank licencees realise this as we understand from the SC Digital spokesperson’s statement that “digital and technology, in our view, are enablers. Only when we solve real customer pain points are we bringing something real to the table, and that’s our goal.”
Hong Kong vs Singapore virtual banks: A different approach?
The HKMA and Singapore’s MAS have got their regulatory requirements right although their prerogatives and approaches are different. According to MAS, to get a virtual banking licence, a company needs to have S$15 million paid-up capital and paid-up capital of S$1.5 billion within three to five years’ time of setting up business. In addition, making the audience of the licencing process clear, MAS also stipulated that at least one company that holds a 20 percent stake in the applying group needs a track record of three years running a technology or ecommerce business. Also, MAS requires applicants to provide five-year financial projections with a clear road map to profitability.
MAS does not want consistently loss-making technology or ecommerce companies to apply for a licence. Also, it is interesting to note that Singapore does not expect the virtual banks to destroy existing value or, in other words, it does not want virtual banking innovation in a way that destabilises the existing banks’ businesses. This is also probably the reason why MAS has limited the number of licences given that traditional banks were allowed to run virtual banks outside of the quota since 2000.
Unlike the HKMA, the MAS seems to be keen to ensure that the virtual banks prove themselves first. A full-fledged bank status will be provided after MAS is assured of the management’s ability to manage risk. The HKMA’s capital requirement of HK$300 million or approximately $40 million is seen as a high bar, although the HKMA’s concern as well is about stability and safety of customer’s money.
At least one fintech startup withdrew its Hong Kong virtual banking licence citing the high cost compared to the European Union where virtual banks need only approximately $6 million to start. Given the eventual capital requirement of $1.5 billion, the MAS is ensuring that only the financially strongest of the technology companies will apply for the licences. MAS’ interest also seems to be in the need to introduce digital innovation and better customer experiences at the incumbent banks through the backdoor.
A challenge for Hong Kong virtual bank operators is the fact that millennials in the region prefer a combination of high technology integration in their banking experiences with a high touch experience, which would mean higher costs and investment in more human resources for on-demand interaction.
One pertinent question that remains is whether Hong Kong needs eight virtual banks at the moment? Is the HKMA experimenting and expecting that there will be some consolidation down the line? Outwardly, it might seem that it is willing to see out which of these challenger banks will be successful in five years compared to the MAS approach of ensuring that only the potentially successful enter the game. In Singapore, the two-staged licencing process also ensures that new entrants can course-correct after the first stage, if need be, and then target a larger market.
Both Hong Kong and Singapore are expecting the virtual banks to take their virtual banking value propositions to populations outside the cities – the Greater Bay Area, which has a population of 68 million, for Hong Kong banks, and the Asean market for Singapore banks – while retaining Singapore and Hong Kong as their headquarters.
“Hong Kong has always played a pivotal role in connecting businesses in Greater China with the rest of the world and Singapore has similarly connected Southeast Asia. In future, that will continue, but the focus with the digital banks will be around connecting the digital economy,” says Harjeet Baura adding that virtual banks in both regions will have a significant wealth play considering the concentration of wealth in the region.
Varun Mittal of EY warns that comparing virtual banks in Singapore and Hong Kong is not an apples-to-apples comparison. “It is important to note that the premise of the digital banking licence in Singapore is that it is sufficient to meet the demand for now; in future, if the country needs more digital banks, it can add more. Hong Kong has other objectives such as connections to businesses in mainland China.
So the difference between Singapore and Hong Kong is not just a matter of numbers, but it is also about the amount of capital, the extent of controls, the overall economic objectives, and the primary concerns of the banking regulator that mandates the need for more players,” Mittal told International Finance.
In Singapore, “MAS supports innovation while seeking to achieve a level playing field among the players. This is why the capital requirement and the end-stage for virtual banking licence is the same. The Singapore model seeks to serve the unserved and underserved segments of the banking market such as the SMEs, the gig economy and the silver economy,” he adds.