FINANCIAL INSIGHT: DIGITAL BANKS Did digital banks fail to disrupt

Most became niche players, yet served their regulatory purpose, said McKinsey & Company Associate Partner Hernán Gerson.

They were touted as game changers, expected to revolutionise the banking industry and cause major headaches to the “old” incumbents. Yet, in the decade since the massive boom in digital-only banks—also known as virtual banks, neo banks, and challenger banks, amongst a plethora of other titles—only a select few have managed to reach profitability in Asia.

“There was a lot of hype, and some of the hype may be due to companies themselves trying to get a better valuation,” Michael Makdad, senior equity analyst for Morningstar. “A lot of it was media-driven [too] because to the media it was something new. So they’re like, ‘Oh, wow, disruption.’ Now that banks have not lived up to the media’s expectations, they see it as a disaster, Makdad noted.

This should not be the case, Makdad, along with other industry experts told Asian Banking & Finance. “The expectation for digital banks depends on your point of view. Consumers, regulators, and investors have very different expectations,” said Hernán Gerson, associate partner,

There was a lot of hype, a lot of it was mediadriven

McKinsey & Company. “[One] of the reasons why [regulators] allowed digital banks to enter the market is for consumers and customers in general. The digital banks were able to deliver a customer-centric proposition with end-to-end digital choice, and in many cases, with much lower fees, and much lower pricing than incumbents.”

This, Gerson said, pushed incumbents to ramp up their digitisation drives, even before the pandemic struck.

“Since digital banks have raised the bar for customer experience, incumbents reacted. You can see how many of these incumbents are now investing heavily in technology, have digital in their core, and are improving their offerings,” Gerson added, noting that this was exactly what regulators wanted: innovation.

Looking back

Whilst the interest and subsequent boom in handing out digital bank licenses only really began during the mid-2010s across Asia, there was one country in the region that has licensed challenger banks as far back as 2000: Japan, where challenger banks have been profitable for more than a decade, according to Makdad.

Models vary. Two of the banks— Seven Bank and Lawson—have a business model of generating profits from fees on ATMs located in convenience stores rather than from making loans. Aeon Bank’s business model, meanwhile, focuses on the low-cost operation and retail banking.

For the rest of Asia, digital banks only emerged at the forefront of the banking industry in 2014, spurred by China’s decision to hand out licenses to Ant Group’s MyBank and Tencent’s WeBank.

Following this, South Korea handed out licenses in 2015, from which two players emerged: KBank and Kakao Bank, launching in 2017. A third virtual bank, Toss Bank, launched in October 2021.

These four digital banks in South Korea and China—MyBank, WeBank, KBank, and Kakao Bank— are now all profitable. It was a story that other digital banks across the region are struggling to emulate.

Ecosystems

The advantage of MyBank, WeBank, and Kakao Bank—which outpaced rival KBank to become profitable in 2019, versus KBank’s 2021—is their connection to their parent companies’ platforms.

“What is interesting about South Korea and China is that most of the successful digital banks there are linked to an ecosystem,” Gerson said. “These ecosystems allow them to tap very cheaply into millions of customers.” The Customer Acquisition Costs for Digital Banks linked to an ecosystem can be as low as 10% of the average acquisition costs of traditional banks. “We’re talking about less than $5 per customer”

“And digital ecosystems provide a unique advantage to reach customers at scale efficiently. So the digital banks that are actually part of an ecosystem or can partner with an ecosystem will be able to provide the right value proposition to customers, he added.

These ecosystems, especially in China and South Korea, provided unique data for the banks as well.