Digital Banking

So, what’s all this hoopla surrounding digital banking?

The new digital banking story that recently captured people’s imagination requires very careful thought. It is not likely to be the panacea that many may be imagining it to be. There’s more to digital banking than what meets the eye.

According to the guidelines Bangladesh Bank published (15 June 2023), a digital bank should be aimed at “… driving greater efficiency in the delivery of financial products and services and expanding low-cost access to finance for the unserved and underserved market segment … (offering) branchless end-to-end virtual banking system (that) can give the banking system the mileage and momentum to reach banking at the last mile of the country”. The guideline further elaborates its thinking on branchless end-to-end virtual banking system: a digital bank shall not have any branch, sub-branch, window, agent, or any ATM/CDM/CRM of its own, instead it can use such infrastructure of other entities; it is restricted to issue any physical instruments for transactions, but it may issue virtual card, QR Code or any other advanced technology-based product for facilitating its customer transactions.

In essence, a digital bank has two key components: a very specific target segment it should aim to serve with a clear purpose (low-cost access to finance for the unserved and underserved market segment), and an operational modality (branchless end-to-end virtual banking system).

Furthermore, it is helpful to underscore the nuanced distinction that is NOT made in the guidelines. There is nothing stopping an existing financial institution with a banking license to offer digital banking services without first obtaining another special license or approval. In fact, the decisions made by the Bangladesh Bank with regards to the first cohort of license applicants further attest to this notion. It is only those entities that do not currently have any banking license are the ones given the green light to proceed first.

Within this context, let us first look at the component relating to purpose and target segment for digital banks: low-cost access to finance for the unserved and underserved market segment. As of May 2023, Bangladesh had 185 million mobile phone subscriptions (more subscriptions than the population since some have multiple SIMs) with a smartphone penetration rate of 43.5%. We know that about 80% of active mobile financial services users accesses those services through feature phones; this means about 15 million people use smartphones for their MFS transactions. We also know that digital banks depend heavily on smartphones. Concrete data about the intersection of unserved/underserved segment who also use smartphones is hard to locate. But it can be estimated that the addressable market for digital banking services is between 15 million (existing MFS customers using smartphones) and 35 million (half of total people in Bangladesh using smartphones since only about half the people are financially included). If we take an average of that range, we arrive at 25 million people – meaningful size but not very large and not growing very fast (since both the smartphone penetration rate and financial inclusion rate are now growing at a lower rate than previously).

With regards to the second component (branchless end-to-end virtual banking system), a digital bank is required to partner with those entities that already have the distribution network (since they cannot build/deploy their own). Ideally, a digital bank would want to partner with entities that have large distribution networks. This means, in the financial sector, they would be entities like bKash, Nagad, or top-10 banks. The incentive for these players to partner with a new digital bank is weak at best. Entities like bKash and Nagad will probably launch their own digital banks (they may not want to give up their distribution network advantages, unless of course they intend to monetize their distribution network while at the same time leveraging that network themselves, thereby pursuing a co-opetition strategy). The top-10 banks may also explore offering digital banking services from within their existing constructs (since the regulation does not bar them from doing so). Therefore, a new digital bank may be left with the choice to partner with smaller entities with smaller distribution networks and stitching multiple networks together. This would require very complicated partnerships with many entities. This will likely be far more cumbersome than what one might initially imagine it to be, especially in an environment where successes with such experiences are quite rare, if any at all exists.

There is also a broader systemic hurdle to think about. Adequate financial literacy among most population segments, and especially among the intended target audience for digital banking, is quite poor in Bangladesh. When this is coupled with the manifestation of fear of technology with regards to carrying out advanced financial transactions beyond simple P2P transfers, it is easy to see that significant effort, investments, and time will be necessary to help overcome such fears for a large population segment.

Things get quite complicated quite fast as you dig deeper into critical questions. pi STRATEGY is not saying this is not possible. It is simply underscoring the complexity in materializing a successful digital bank in Bangladesh. A few things to keep in serious consideration as digital banking aspirants move forward:

Regulations: The regulations published so far are work-in-progress and will likely undergo several iterations before things settle. This is not surprising. A similar path was evident in MFS regulations between 2011 and 2015, after which it began to settle. Regulatory uncertainty will persist in the short to mid term.
Investments: The TK1.25B figure is a fraction of the real investments required to succeed. Some industry leaders feel that the figure will be around TK10B (8X). It will likely be more as time to succeed increases.
Capabilities: The capabilities required to succeed in digital banking are very different from what they are for conventional banking, or MFS. Bangladesh has a dearth of skilled people that fit this bill. It would be naive to think that many success stories will emerge with the current talent pool.
Profitability: Despite the billions of dollars that have been invested in digital banking in Asia, not many are profitable yet. For example, in Hong Kong the cumulative losses (2020-22) for the eight digital banks have been US$1.2 billion.

In Asian markets where there are examples of successes, it is often only one (max two) player(s) in a given market that succeeds. Furthermore, in all those success cases (Rakuten in Japan, WE Bank in China, Kakao in South Korea, AirTel in India), there are two key lessons. First, each of them had prior experiences in relatable markets, which helped them pivot into digital banking. Second, each of them were able to leverage those experiences to rapidly reach significant scale (15+ million active customers) in digital banking.

So, what might this mean for the digital banking aspirants in Bangladesh?

pi STRATEGY believes that the MFS market experience in the country provides some likely scenarios. Over the last 12 years, 25+ MFS licenses were issued, about half of them are currently operational, one player owns the lion’s share while two others are in distant second/third positions. None of the players have achieved meaningful profitability to-date, however, each of them made considerable investments and reached meaningful share of active customer base (15+ million) in the MFS market today.

It is pi STRATEGY’s view that unless a digital banking aspirant is able to:

make significant (US$100-150M) and sustained (10+ years) investments,
possess/acquire and deploy relevant world-class capabilities and partnerships rapidly, and
build on successes in relatable markets at scale (millions of active users),

their success in digital banking is likely to be uncertain.

This article was written in January 2024.