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Gulf digital banks must vault high barriers to entry in bid for market share

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Gulf digital banks must vault high barriers to entry in bid for market share

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Emirates NBD Bank-backed Liv, a digital-first operator, is adding more than 15,000 new customers every month.
Source: Tom Dulat/Getty Images Entertainment via Getty Images Europe

Digital banks in the Gulf Cooperation Council, or GCC, will likely have to invest heavily in acquiring younger customers and target areas underserved by incumbent lenders if they are to gain significant market share.

Saudi Arabia's central bank, SAMA, has approved two digital banking licenses, including for Saudi Telecom Co.-owned STC Pay, while in the United Arab Emirates at least one stand-alone digital bank — Zand — is set to launch later this year. It would be the first new bank in more than a decade.

The region is well served by a large number of established banks. Yet the lesson learned globally from challenger banks, also known as neobanks, has been that there is a segment of young and digitally savvy customers who are often dissatisfied with conventional lenders.

"Currently, there are very few compelling offers targeting these customers in the UAE or Saudi Arabia, so we believe that the first digital banks with a compelling product offering and superior customer experience will be able to grab a share of the market," said Jorge Camarate, financial services practice leader in the Middle East and partner with Strategy&, part of the PwC network.

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A survey published in July by YouGov, carried out on behalf of banking software platform Backbase, found that around one-third of respondents in the GCC see their current bank as "weak when it comes to offering seamless access to online banking services." Some 77% use online banking at least once a week, while 44% indicated a willingness to switch provider due to poor customer service.

"Incumbent banks have certain innate challenges — legacy solutions, siloed systems at the back end, switching between apps for banks employees — which can result in a very broken experience [for] the end customer," said Saqib Khan, head of Middle East at Backbase.

Most banks are working hard to overhaul their digital offerings, says Khan, but they still need to view challenger banks warily. "Incumbent banks have to look at them as an emerging threat, if not in the near future, then certainly in a year or two."

High acquisition costs, profit worries

One thing is certain: customer acquisition costs will be high for newcomers. Internationally, challenger banks have had to invest significantly in customer acquisition by offering better rates, lower fees or sign-up bonuses, said Strategy&'s Camarate.

In the expat-dominated UAE, many banks use their sales force that works with corporates to bank new employees when they first arrive in the country, posing an additional challenge for these neobanks, which do not have these relations with corporates, he added.

"As a result, we believe that neobanks in the UAE and Saudi Arabia will also have to invest significantly in customer acquisition, which will impact their profitability in the short term," said Camarate. "While some of these investments are offset by a structurally lower cost base, many neobanks only reach breakeven after one or more years of operations."

Digital lenders in the Gulf may also end up replicating some of the weaknesses of the neobank business model. While better use of technology allows them to deliver a superior customer experience at a lower cost than legacy banks, neobanks have tended "not to focus on building the necessary underwriting and risk management capabilities required to compete in the lending business," said Camarate. "We believe that a similar pattern may occur in the UAE and Saudi Arabia."

Digital banks in Saudi Arabia will need to "initially target the higher end of the risk curve," given the robust risk assessment models of the incumbent banks, according to Chiro Ghosh, vice president, research at Bahrain-based financial services provider SICO BSC.

Speaking at an industry summit in June, Olivier Crespin, CEO and co-founder at Zand Bank, said the bank planned to provide retail customers with products such as cards, loans, accounts and personal financial management. It will offer an interest rate of around 2% — well above the prevailing rates — in a bid to attract customers.

It will also target corporate customers, where it will focus primarily on supply chain financing, including financing of small and medium-sized enterprises. Crespin expects the bank to be operational before the end of 2021.

Big gaps for fintechs to target

Apart from stand-alone banks, considerable headway is being made by fintechs in the region, some of which have partnered with incumbent lenders in areas such as wallets, payments and robo-advisory.

Many fintechs are delivering entirely new services or catering to customers not currently served by banks, according to Hussain Almarhoon, managing partner at Hala Ventures, a Riyadh-based venture capital fund that has invested in buy-now, pay-later provider Tamara FZE and Abu Dhabi-based robo-advisory firm Sarwa Digital Wealth (Capital) Ltd.

Banks in Saudi Arabia prefer to write loans with larger ticket sizes and tend to favor corporates and older clients, in part because that is where the wealth is concentrated, rather than among the younger generation, said Almarhoon.

By contrast, a buy-now, pay-later fintech can write a very small but higher-risk loan quickly, serving a customer demand unmet by the banks, said Almarhoon. Similarly, Sarwa's robo-advisory offering appeals to a mass affluent segment that has traditionally been ignored by many regional banks that tend to concentrate on wealthier clients. "The gaps for newcomers to grasp are massive," said Almarhoon.

Large banks must adapt

Whether incumbent banks will be able to handily defend retail market share from challengers will depend to a large extent on how advanced their own digital offerings are. In Saudi Arabia, banks are already at an "advanced stage of digitization, taking away the earlier mover advantage for digital banks," said SICO BSC's Ghosh.

In the UAE, at least two banks have established stand-alone digital banking brands. Liv, operated by Emirates NBD Bank PJSC, has about 480,000 customers in its home market, as well as roughly 75,000 in Saudi Arabia, and is adding more than 15,000 customers per month across both markets, a spokesperson for the bank said. It recently launched a premium subscription plan priced at 24.90 dirhams per month with offerings including a higher interest rate and lower foreign exchange fees, similar to the likes of Revolut Limited and N26 GmbH.

"Given the strong market acceptance for Liv in the UAE and Saudi Arabia, we are actively looking at opportunities to expand the platform to other millennial majority markets in the region and beyond," the spokesperson said.