The majority of digital banks in Asia-Pacific (APAC) face higher credit risks compared to their incumbent competitors as they tend to focus on undeserved retail or unbanked market segments, a report by Fitch Ratings state.
However, in the report released on Oct 8, Fitch Rating analysts Tamma Febrian, Ruby Tsai and Peter Huang note that digital banks tend to charge higher loan interest rates to compensate for the higher default rates.
“Parental links often mitigate vulnerable standalone profiles,” the analysts say. They note that liquidity risks can be mitigated by parental support, although this support may be constrained by the banks’ rapidly growing balance sheet.
However, the analysts recognise that it is still challenging to manage credit risk while growing loan books and targeting underserved segments, especially in countries with low household income.
“This has been highlighted by a recent spike in credit costs at some digital lenders against the backdrop of relatively high interest rates, for example in Indonesia, the Philippines and Hong Kong,” the analysts add.
Digital banks in APAC have experienced varying levels of profitability.
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At least 16 of the 45 digital banks in APAC have achieved breakeven, including six in Japan where such banks are usually risk averse and have a longer profitability record, the analysts note.
However, the analysts note that Hong Kong, Taiwan and Singapore digital banks, with shorter operating histories than Japan and Korea, are still loss-making. The analysts identify a more limited pool of undeserved customers and dominant market position of the incumbents as some challenges that the Singapore and Hong Kong digital banks face. Furthermore, the incumbents in Singapore and Hong Kong have relatively efficient cost structures that make it more difficult for digital banks to compete within these territories. Singapore’s average cost-to-income (CIR) ratio is 42% of the banks’ revenues while Hong Kong’s average CIR ratio is 39% of its banks’ revenues.
The regulatory landscape for digital banks within APAC also vary greatly.
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In Singapore, Hong Kong, Thailand and Korea, regulators often expect digital banks to be partially owned by incumbent banks or established non-financial companies, the analysts state.
“Singapore and Malaysia also adopt a phased-in approach with less stringent initial requirements but tighter business restrictions such as asset size or deposit caps to mitigate risks associated with their untested business models,” the analysts add.
The analysts note that given the relatively small market size in Singapore, regulators are unlikely to relax the cap on the number of licenses for digital banks.
Further to the report, the analysts state that more digital banks are in the process of optimising their balance sheets to reach or sustain profitability. For example, the analyst note that some with more competitive funding capabilities are diversifying into safer residential mortgage or corporate lending to reduce the overall risk in their loan portfolios.
Looking ahead, the analysts are of the view that falling interest rates in most markets in APAC in 2025 are likely to improve borrowers’ repayment capacity and reduce bank funding costs, however, they recognise that these effects will likely be felt with a lag and lower rates may boost risk appetite within the sector.
