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The Future Of Banking: The Incumbents Strike Back

The pure-play virtual banks are getting squeezed just as the pandemic is hitting their nascent business models. S&P Global Ratings believes the health crisis has reset the digital competition, with the new entrants under strain at a vulnerable moment, and with traditional players aiming vast resources at digital services.

Pre-COVID-19, the question in Asia Pacific of whether traditional banks would use branches was a "future state" consideration (see "The Future of Banking: Virtual Banks Chase The Dream in Asia-Pacific," published July 16, 2019 on RatingsDirect). Following the onset of the virus, however, this notion was jettisoned into the present. Many traditional banks closed branches or otherwise halted their physical distribution network, all while expanding their digital offerings.

What was shaping up pre-COVID-19 as a moment of glory for virtual banks is turning into an ordeal for some. The economic malaise has hit many lenders, but the less established institutions are often more vulnerable. The virtual banks have a low market share relative to traditional banks. In many cases, virtual banks have highly concentrated business profiles, often need to rely on higher interest rates to attract deposits, and have small, unseasoned lending books.

The outbreak has exposed gaps in the business model of some virtual banks. Many will need to revamp their strategies or find a stronger partner with which to merge. Some may not survive. Some have already conceded.

Chart 1


The Case For Digital Banking Remains Strong…

Despite the difficult environment virtual banks are facing, our view is that the concept is here to stay. In emerging markets, the case for virtual banks is compelling. Longer-term, they may yet be an effective means of reaching vast unbanked populations, particularly on the back of increasingly wide smartphone use and access to higher speed internet. The pandemic has revealed an essential need for credit for all during crisis periods. For many millions of people, virtual banks may be the solution.

Through financial inclusion, virtual banks may eventually achieve wider penetration of the banking market and greater revenue. The virtual banking trend may also reduce shadow banking, which we view as a positive. The excessive lending rates sometimes associated with this realm should start to fade as regulators take a firmer hold on the sector.

The allure of cheaper basic banking products will continue to attract customers to virtual banks, particularly in developed markets. Many regulators in developed markets are keen to promote price-competition for basic banking services for the benefit of retail and small and midsize enterprise (SME) banking customers. Virtual banks can help drive that competition.

…But Virtual Banks' Vulnerabilities Are Becoming Apparent

All of that said, the pandemic has tested many virtual banks. Lenders across the world are grappling with higher credit losses and spikes in default rates. Virtual banks are not immune to the strains. Many virtual banks in Asia-Pacific have not been tested through a full credit cycle.

Furthermore, some virtual-only banks that relied on high deposit rates to attract customers are finding this model difficult to sustain given the prevailing ultra-low interest rates. In the absence of a meaningful core value proposition, we wonder how sticky deposits will be if above-market deposit rates are not maintained.

Losses are climbing for some global virtual banking names such as Monzo Bank Ltd. and Revolut Ltd. The U.K.-based Monzo reported a loss of US$145 million for the fiscal year ended Feb. 28, 2020, significantly higher than the US$62 million it lost in the previous year.

Newly licensed virtual banks in Hong Kong are doling out high deposit rates and cash rebates on card spending to garner customers. These deposit rates are almost three times as high as those offered by the traditional banks.

In Australia, virtual-only banks such as Xinja Holdings Ltd.(Xinja), Volt Bank Ltd. and 86 400 Ltd. had to cut deposit rates after the central bank announced a series of rate cuts starting early 2020. Xinja also had to stop accepting new savings accounts to keep costs under control and, in December 2020, announced its decision to hand back its banking license.

The Pandemic Tests Nascent Business Models

Many virtual banks have narrow revenue streams that are concentrated in a limited range of simple products. The economic downturn has exposed such concentration risk. For example, demand for travel cards--a staple of U.K.-based virtual banks--has slumped alongside reduced people movement. Even for virtual banks that may want to diversify their product offerings, management attention has been focused principally (and necessarily) on managing the effect of the virus on business models.

The economic fallout arising from the pandemic may also limit the virtual banks' access to capital.

We expect the traditional lenders may start buying the virtual banks, or other merger and acquisition activity may occur. For example, National Australia Bank Ltd. (NAB) recently said it would acquire 86 400, a virtual-only bank. NAB is one of Australia's four biggest banks.

While often happening under distressed circumstances, such mergers can make good strategic sense. Many new virtual banks are small. They often have modest risk management and IT budgets. Traditional banks have large IT budgets and years of expertise in risk management that they can share with their virtual acquisitions.

While not a significant issue so far, risk management issues may affect small or recently established virtual banks and could trigger a flight to quality favoring traditional banks.

Recent examples of risk management problems in the virtual banking environment include:

  • Ride-hailing operator Grab Holdings Inc., which is one of the virtual banking license applicants in Singapore, was recently fined due to breached data protection laws. The state's Personal Data Protection Commission said the company did not put in place robust processes to manage changes to its information technology system and, consequently, exposed the personal data of its customers.
  • A data breach also occurred with another Singaporean virtual banking license applicant and gaming hardware firm, Razer Inc.

While COVID-19 has hit the virtual banking sector hard, we note that larger, stronger virtual banks have contended better with the difficult environment. For example, WeBank Co. Ltd. has maintained generally stable asset quality ratios during the pandemic, and benefits from strong sponsor backing (Tencent Holdings Ltd.). We believe that virtual banks embedded into larger groups will likely maintain the benefits of strong financial investment power and focus on client experience.

Traditional Banks Improve Their Digital Game

COVID-19 has shifted customer preferences toward digital offerings. This made it more urgent for traditional banks to launch their own virtual operations, or strengthen their existing digital capabilities.

For instance, U.S. based JPMorgan Chase & Co. recently announced plans to launch a digital retail bank in the United Kingdom. Singapore's United Overseas Bank Ltd. started its first mobile-only digital bank, known as TMRW, in Thailand in 2019. It launched TMRW in Indonesia in 2020.

More digital and client-focused initiatives by traditional banks during the pandemic is a point of competitive tension for virtual banks. In response to COVID-19, traditional banks have introduced new services such as cloud-based call centers, remote account creation, chatbots that can manage queries related to the pandemic, digital trade financing, electronic know-your-customer systems, and "smart" online loan approvals. A strong customer response has encouraged traditional banks to continue down the virtual path, filling gaps in their service offerings.

Virtual banks don't need to maintain branch networks and, therefore, have an advantage over traditional banks because of lower premises costs. However, the traditional banks have been rapidly rationalizing their branch network through the outbreak. The traditional banks retain their size and significant scale advantages. They have more money to spend on technology, and can spread such costs over a significantly larger customer base.

Traditional Lenders Take A Rationalizing Approach

Some Asia-Pacific banks have been rationalizing their branch networks in response to declining branch traffic and the surging use in digital services. The outbreak has only accelerated an established trend.

New Zealand-based ASB Bank Ltd. has seen a 42% decline in branch transactions over the past five years. About 85% of their customers prefer to bank online. In August 2020, the bank announced a permanent move to operating three days a week for 23% of its branches. It also closed 8% of its branches.

Likewise, for an Indian traditional lender, HDFC Bank Ltd., 95% of its customer-initiated transactions are through the internet and mobile. Some of the largest global banks such as Deutsche Bank AG, Commerzbank AG, Wells Fargo & Co., and Credit Suisse AG have also announced plans to cut their branch networks.

In this environment of ultra-low interest rates and razor-thin net interest margins, digital operations offer traditional lenders important cost efficiencies. DBS Bank reported about a 30 percentage point difference between the cost-to-income ratio of its traditional and digital segments in 2020 (see chart 2).

Chart 2


Traditional banks in Asia-Pacific have been widening their digital offerings during the outbreak. New Zealand-based Kiwibank Ltd. launched an SME lending product that uses an online automated application and credit decision process. The program analyzes a borrower's profit and loss data, balance sheet, invoices, organization data, and accounts. This has significantly cut the time needed to process a credit decision.

We believe more traditional banks will increase small-ticket lending as the costs to service this segment come down with such automation.

Korea's major commercial banks have started offering retail loans online. Customers can access the service through their mobile phones, typically getting quick approval.

Big Tech players have ventured into financial services largely by adding the offering to their existing platform. One example is seen in the way Tencent's WeChat messaging app morphed into the giant payment service WeChat Pay.

The integration of banking services into an "ecosystem" of internet services should drive customer engagement. For example, HDFC Bank launched myApps, a suite of customizable apps, to enable large institutions such as urban local bodies, housing societies, clubs, and religious societies to digitize their ecosystems.

It has not always been smooth sailing for the traditional banks' technology moves during COVID-19. Some institutions have seen system crashes following surges in the customer volumes during the pandemic. We believe banks will prioritize infrastructure revamps and increase spending in IT to minimize such disruptions. We have begun to see such spending among Hong Kong-based banks. Standard Chartered PLC and The Hongkong and Shanghai Banking Corp. Ltd. have announced increased investments to digitalize their operations.

More traditional banks will likely buy or otherwise partner with pure virtual banks to jumpstart their digital banking operations.

Chart 3


We expect all banks to move to cloud services. Operating in the cloud can offer banks scalability and flexibility to accelerate their digital transformation, as well as significant cost efficiencies. "The Future Of Banking: Bank Cloud Adoption Goes From Blue Sky Thinking To Economic Necessity," Feb. 8, 2021).

More Banking Jurisdictions Hop On The Digital Bandwagon

We have seen meaningful regulatory developments in Asia-Pacific in 2020. These have ranged from licensing new virtual banks to instituting digital frameworks. The pandemic has also prompted some regulators to delay such initiatives. In April 2020, the Australian Prudential Regulatory Authority (APRA) suspended its plans to issue new banking licenses for at least six months. Below is the summary of select jurisdictions in Asia-Pacific covering key developments.


Virtual Banking Regulatory And Market Developments In Asia-Pacific Banking Systems Since July 2019
Stage of licensing of virtual banks
Philippines Window open for applications
Malaysia Window open for applications
Singapore Four applicants shortlisted. Expected to begin operations in 2022
Korea The regulator approved a preliminary license for Toss Bank. Final license expected and operations may start in 2021
Taiwan Three licenses issued. Rakuten Bank started operations in January 2021, and Line Bank is likely to begin operations in the first half of 2021
Hong Kong Seven of the eight licensees have begun operations
Note: Rest of Asia-Pacific: There have been no significant regulatory developments since July 2019 regarding virtual banking frameworks for banking systems in India, Indonesia, Thailand, Australia, China, Vietnam, Japan, New Zealand, and South Korea. For updates prior to July 2019, please see "The Future Of Banking: Virtual Banks Chase The Dream In Asia-Pacific," July 17, 2019. Source: S&P Global Ratings.

Philippines  (Contact: Nikita Anand;

In December 2020, the central bank issued guidelines for the establishment of digital banks. The application window is open though no license has been given out. As per the guidelines, digital banks require a minimum capitalization of 1 billion Philippine pesos (US$20.6 million) and can perform all basic banking services. These banks are not permitted to establish a branch except for an office dedicated to receiving and addressing customer concerns.

Malaysia   (Contact: Duan, Nancy;

The central bank released draft guidelines in December 2019. The draft was later updated to propose a more simplified regulatory framework for digital banks in their foundational phase. The consultation period ended in June 2020. In December 2020, the final policy framework was released. The central bank requires the virtual banks to demonstrate an ability to facilitate financial inclusion. The period for applications for digital licenses is open until June 2021. The central bank may grant up to five licenses by the first quarter of 2022.

Singapore  (Contact: Ivan Tan;

In January 2020, the Monetary Authority of Singapore (MAS) received 21 virtual-banking applications. Fourteen of these met the eligibility criteria and were shortlisted in June 2020. MAS later requested eligible applicants to review and present their business plans and assumptions in light of COVID-19 related changes. In December 2020, MAS shortlisted four applicants to operate digital banks. These entities should begin operations from early 2022.

Taiwan  (Contact: Eunice Fan;

In July 2019, the regulator issued three full-scale virtual bank licenses to Line Bank, Next Bank, and Rakuten Bank. Rakuten Bank started operations in January 2021, and Line Bank is likely to begin operations in the first half of 2021.

Hong Kong  (Contact: Fern Wang;

The regulator granted eight virtual banking licenses in Hong Kong between March and May 2019. Seven of the eight licensees have already begun operations.

Korea  (Contact: Daehyun Kim;

We are likely to see a third virtual bank enter the market in 2021. The regulator approved a preliminary license for Toss Bank (operated by one of the major fintech companies specializing in money transfers, Viva Republica) in December 2019. The bank plans to start operations this year after receiving a final license.

Rest of Asia-Pacific  

There have been no significant regulatory developments since July 2019 regarding virtual banking frameworks for banking systems in India, Indonesia, Thailand, Australia, China, Vietnam, Japan, and New Zealand. For updates prior to July 2019, see "The Future Of Banking: Virtual Banks Chase The Dream In Asia-Pacific," July 17, 2019.

S&P Global Ratings believes there remains high, albeit moderating, uncertainty about the evolution of the coronavirus pandemic and its economic effects. Vaccine production is ramping up and rollouts are gathering pace around the world. Widespread immunization, which will help pave the way for a return to more normal levels of social and economic activity, looks to be achievable by most developed economies by the end of the third quarter. However, some emerging markets may only be able to achieve widespread immunization by year-end or later. We use these assumptions about vaccine timing in assessing the economic and credit implications associated with the pandemic (see our research here: As the situation evolves, we will update our assumptions and estimates accordingly.

Related Research

Editor: Jasper Moiseiwitsch.

Digital Design: Evy Cheung.

This report does not constitute a rating action.

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Primary Credit Analysts:Gavin J Gunning, Melbourne + 61 3 9631 2092;
Harry Hu, CFA, Hong Kong + 852 2533 3571;
Fern Wang, CFA, Hong Kong (852) 2533-3536;
Research Assistant:Priyal Shah, CFA, Mumbai
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Lisa Barrett, Melbourne + 61 3 9631 2081;
Sharad Jain, Melbourne + 61 3 9631 2077;
Daehyun Kim, CFA, Hong Kong + 852 2533 3508;
Eunice Fan, Taipei + 886287225818;
Deepali V Seth Chhabria, Mumbai + 912233424186;
Nikita Anand, Singapore + 65 6216 1050;
Rujun Duan, Singapore + 65 6216 1152;

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