The ongoing Covid-19 pandemic, which has brought about social-distancing measures and lockdowns globally, has accelerated the shift towards digital services, including banking.
According to a report by Fitch Ratings on August 17, aspiring digital banks looking to break into the Asian markets may “struggle” to attain the critical mass necessary to reach business viability amid the economic shock brought about by the pandemic.
This is especially so in developed markets where competition in incumbent banks was already fierce. Moreover, the flight to quality during the crisis has benefitted established banks, in terms of access to funding, says the credit rating agency.
According to the report, the crisis has also forced established banks to accelerate their digitalisation efforts, reducing the risk of complacency and potentially closing off openings for new entrants.
Nevertheless, digital banks in the Asia-Pacific (APAC) with the right pedigree and financial and technological resources should still be able to realise the region’s market potential in the longer term.
However, the new entrants’ primary target segment – those without existing accounts with banks and the underserved – may face additional barriers from the target segment’s being disproportionately hit by the economic downturn, reducing opportunities for profitable lending.
Fitch says it believes these adverse effects will more than offset the impact of greater digital usage “at least in the near term”.
It also continues to believe that the greatest opportunities for virtual banks to tap into such underserved segments in the Asia Pacific (APAC) region lie in emerging markets like India, Indonesia, and the Philippines, where banking service penetration “remains low”.
However, these countries are among the worst affected by the pandemic in the region, and even in the longer term, their potential may be hampered by lagging digital infrastructure.
There also remains the risk that aspiring virtual lenders may misprice credit risks, which may lead to a negative impact to the industry.
While some digital banks in the APAC region have turned profitable such as Tencent-backed WeBank in China and the eponymous KakaoBank in Korea, most digital-only lenders’ risk frameworks and business models have not been tested through the economic cycle.
The current steep downturn could reveal weaknesses in the approaches of some virtual banks.
“The challenges presented by the pandemic have reinforced our belief that there is likely to be limited rating impact on our portfolio of banks from the entrance of virtual banks in the near term,” says the agency.
“However, those digital banks that are able to survive or thrive through the downturn are likely to be better-resourced and may pose a greater competitive threat over the medium term to digitally unprepared rivals,” it adds.
Citing examples, Fitch says the virtual banks likely to provide more formidable competition for incumbents over the medium term include those backed by established technology platforms such as Facebook or Alibaba, or corporates with deeper pockets such as Reliance or Singtel.
“These backers are more likely to be able to sustain the heavy financial investment necessary for entrants to attain scale, maintain cost competitiveness and survive the initial loss-making stages of a start-up. Strong name recognition associated with the parent may also help to generate credibility and aid in building a customer base, as well as providing potential synergies that may give the lending business a competitive edge,” says Fitch.
