Digital banking meets hard realities in SEA’s emerging markets

Digital banks have sprouted in Southeast Asia over the last couple of years as new and nimble financial players grabbed at opportunities to make a play for “the underbanked.”

Financial inclusion is often cited as a worthy goal, with banks eyeing new customers out in rural areas. Running a digital network where there are few or no physical bank branches means lower overheads, and digital banks can operate at a fraction of incumbent players’ expenses.

Governments moved with the new wave. Singapore, Malaysia, and the Philippines have given out digital banking licenses, while Indonesia has allowed tech companies such as Grab and Sea to buy and transform traditional institutions into digital banks.

Image credit: The Business Times

Yet, in most markets in which they operate, digital banks have yet to make the kind of impact that they and their investors had envisioned.

Florian Hoppe, partner at Bain & Company, puts it baldly: “The reason there’s an unbanked population is that they have very little money and very little access to products. You cannot bank a subsistence farmer – that’s just the reality.”

There is a misunderstanding of what digital financial services can do, he says. “There’s a big chunk of the population in Southeast Asia that’s not addressable by digital financial services. There’s just no money, so there’s no economic case for that.”

Sumit Kumar, managing director at Boston Consulting Group (BCG), agrees, saying there is not a lot of revenue to be gained from that customer segment. Digital banks should instead aim to make banking a different experience for the unhappily banked population in emerging markets, he says.

With typically lower operating expenses, digital players have a cost advantage that they can pass on to customers. Traditional banks’ operating expenses can account for up to 55 percent of operating income. Digital banks’ costs could be, at most, 35 percent of their income, Kumar notes.

It’s “the inefficiency of legacy banking” that accounts for the difference, he adds.

The banking business, however, is significantly more tradition-bound than the “move fast, break things” model that tech companies adopt. A legacy bank’s business model is based on the fundamentals of building up customer deposits and a loan book with low non-performing loans (NPLs). Failure is not an option.

Regulators watch the sector like a hawk and impose rules and requirements that are resolute, with few gray areas to maneuver. The last thing they want is a bank imploding and sparking off a run on other players.

Greg Krasnov, founder and CEO of Tonik Bank in the Philippines, understands the situation all too well. The digital bank, operating in the country since March 2021, started out with a rural bank license handed out in a regulatory sandbox set up by the Philippines’ central bank.

“People without a deep understanding of banking economics are trying to run their customer acquisition based on digital-economy metrics,” says Krasnov.

Economics of banking