For decades traditional banks have been content to serve the affluent and middle class when it comes to retail banking services, and mid to large enterprises on the corporate side. In support of government efforts to serve what is seen as the largest constituency of businesses in the region – the micro and small business (MSB) segment – banks have rolled out banking services that is marketed as MSB-friendly. But that is mostly a marketing ploy meant to acquiesce to government pressure.
At least that was until banks discovered that there is financial and goodwill to gain in serving the MSB segment. It also helped that in recent years tech-led businesses have started to enter the financial services sector initially through faster payments and e-wallets, and more recently with loans catering to those stumped by banking red tape.
These neobanks, as they are referred to in Europe, have their eyes set on the region’s 196 million unbanked and 324 million mobile internet users (per Google guestimate) – a population size, traditional banks may have ignored in the past but likely cannot continue to do so in 2020 and beyond.
The reason? Banking regulators in the region are issuing virtual banking licenses under the guise of accelerating financial inclusion.
“Traditional banks are facing increasing competition in service innovation, which reinforces the need to redesign conventional banking models. Virtual banks may be nimble compared to the incumbents. Still, they face three immediate challenges: they need to demonstrate to regulators their ability to comply, they need to monetize data, and they need to turn compliance into a competitive advantage,” said Venky Srinivasan, group vice president, JAPAC & Middle East, Oracle Financial Services.
Hong Kong may well have been one of the accelerators of the virtual banking phenomenon following the Hong Kong Monetary Authority’s approval of eight banking licenses on 27 March 2019, after receiving 33 applications on 31 August 2018.
For now, speculation is ripe as to what these virtual banks will do to Hong Kong’s current banking industry.
Is the threat real?
Few would argue that the real beneficiary of the entry of virtual banks is the customer, particularly aspiring entrepreneurs launching their micro business and small businesses subsisting on hand-to-mouth buying.
The Motley Fool investment writer and independent analyst Christopher Chu doesn’t seem to think virtual banks are a credible threat to incumbent banks – at least not in Hong Kong. He estimates that the new eight entrants may reach a combined profit of 7% of HSBC in five years.
For their part incumbent banks are not sitting idly on their profits. In August 2019, incumbent banks like HSBC, Hang Seng Bank and Bank of China Hong Kong have waived fees on entry accounts as well as minimum bank balances for small businesses. Banks have also started to tighten cost control – read staff cuts – in a bid to trim operating expenses.
Endgoals of virtual banks
Ray Wyand, CEO and founder of gini, acknowledged that Hong Kong’s biggest problem is not enough banks. Compared to other markets in the region, like Indonesia and the Philippines, the quality of banking services in the city is relatively high.
“I think what we've seen in the domestic market is there are still gaps and I don't think that any of the virtual banks their endgame is to dominate the Hong Kong consumer market,” he commented.
He pointed to the Asia region as playing to the ambitions of these virtual banks. “My guess is that most of their business plan starts here but involves trying to become a broader Asia player,” he added.
He noted that in Europe neo banks like revolut may have started in one country but have expanded to other markets as they build and scale out the technology.
“For them what's important is that they can create good technology, understand the consumer mindset and take that to other market or similar consumers. He conceded that, in Asia, this may not be as easy given that Hong Kong people are very different to people in Indonesia, Taiwan, etc. So my guess is that these virtual banks are going to be razor-focused finding customers' pain points. And that's going to be the challenge I think,” concluded Wyand.
Virtual bank playbook
Wyand believes that revenue generating will not be the immediate goal for these incoming virtual banks.
He believed the playbook for that these virtual banks will consist of launching services that banks don't make money from and don't particularly focus on and to aggressively pitch them to consumers.
Wyand noted that incumbent banks make money on foreign exchange, investments loans, mortgages. These are very profitable for banks in Hong Kong. “I don't think that that's the area that virtual banks will go after,” he commented.
The immediate goal for virtual banks is to acquire customers by offering banking services for free.
“They're not going after the core activities that drive the balance sheet of a bank,” he postulated citing the example of neo banks in the UK that started off around expense management and payments, and moving into credit loans only later into the business model. He doesn’t see these virtual banks as becoming the primary bank for someone’s life savings.
“In Hong Kong, the virtual banks would go after savings first because for young people it's hard to save money. I wouldn't say at the highest level for HSBC that number one priority is to get to saving accounts of 19-year olds in Hong Kong. I think that they feel in many cases left behind,” elaborated Wyand.
Karen K L Tsui, a partner at accountancy firm PKF Hong Kong, says virtual banks may be popular amongst business users, “its concept is relatively foreign to the general population, especially amongst the older generation. They prefer to use traditional banks, because they are well established and have a proven track record. Also, customers prefer their money managed by a trusted individual via face-to-face interactions. This personal touch may be lacking in most virtual banks,” she explained.
With paid-up capital averaging HK$1.9 billion, the new virtual banks will bring competitive pressure to bear in the local market. But neither Wyand nor Chu seemed in fear for incumbent banks.
Wyand reckoned that incumbents are not going into panic mode with the arrival of these virtual banks. That said these banks are preparing their businesses for the long-term gradual erosion of their customer base.
Chu sees Hong Kong’s traditional banks needing to issue larger loans amid slower growth in both China and Hong Kong where credit demand is anaemic. “I believe virtual banks are unlikely to disrupt their dividend payouts but the economic environment just might,” he concluded.