Digital banks will spur financial innovation but limited threat to banks

KUALA LUMPUR: While digital banks are disruptors relative to traditional banks and will intensify competition, their impact will be in the next three years, given the regulatory restrictions on their asset size, that is, not more than RM2 billion, said RAM Rating Sdn Bhd (RAM Ratings).

The credit rating agency said the entry of digital banks is expected to spur more financial and accelerate the digital transformation of the Malaysian banking industry, but on the whole, the assets of the five digital banks would only represent 0.3 per cent of the industry’s.

“Bank Negara Malaysia (BNM) also requires digital banks to focus on financial inclusion to address the market gaps in the underserved and unserved segments.

“This will temper the head-on competition with traditional banks in the mass retail and SME markets, ” said RAM Ratings’ Institution Ratings co-head Sophia Lee in conjunction with the release of RAM’s latest commentary titled “Digital banks will spur financial innovation, not yet a to traditional banks”.

BNM’s issuance of up to five digital banking licences has attracted various potential applicants, including technology companies, fintech players and financial institutions vying for a slice of the digital banking pie.

By utilising technologies based on artificial intelligence or other forms of predictive algorithms along with big data analytics, digital banks may undertake alternative assessment of credit risks to enable greater financial inclusion, and has the advantage of significantly lower operating costs, given the reduced need for human intervention.

Potential beneficiaries include the eight per cent of unbanked adult population in Malaysia, as well as small and micro enterprises that are unable to access traditional bank financing.

Nonetheless, digital banks’ profitability is likely to be constrained in the early years, similar to most start-ups, given the hefty initial outlay to develop their ecosystem and the need to build up scale by occasionally offering promotional rates amid the competitive business environment.

“Digital banks will also be subjected to the same regulatory framework as commercial banks although capital adequacy and liquidity requirements will be simplified during the foundational period (of between three and five years).

“That said, we do not expect digital banks to compete with unsustainable rates as they are required to prove their profitability and business sustainability to maintain their licences,” said RAM Ratings.

Most Malaysian banks’ digital ventures to date have predominantly involved payments rather than lending. One of the main hurdles is the absence of a BNM-approved digital identity-verification process.

Notably, the central bank will soon allow eKYC (electronic know-your-customer) solutions for the digital on-boarding of individuals in the financial sector.

This will enable banks to digitalise the on-boarding process to enhance convenience and reach, besides reducing the cost of providing financial services.

In the longer run, digital banks may have a meaningful impact on the banking landscape, especially for traditional banks that do not innovate or strengthen their digital propositions quickly enough.

“We anticipate the banking sector to undergo further digital transformation in the longer term, ” it added.

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