Onerous conditions for new digital bank licences enable local banks to forge ahead with digital plans

“At UOB, we welcome the diversity that the new players may bring with the digital bank licences to be granted,” says Wee Ee Cheong, CEO of United Overseas Bank (UOB), soon after the announcement during an Association of Banks in Singapore dinner. “Banking will continue to be shaped by how financial service providers ensure that customers’ interests are not only anticipated, met and protected but that their experiences are also differentiated,” he adds.

On July 29, Piyush Gupta, CEO of DBS Group Holdings, poured cold water on plans that potential applicants for the licences could have. In his view, the local market’s unbanked areas are limited to two sectors: small and high risk. “There is an underbelly served by moneylenders, so someone could compete with the moneylenders. It’s a high-risk segment. The credit models that people have used in other countries don’t necessarily work — for example, at Funding Circle Holdings and LendingClub, delinquency has gone through the roof,” he says.

Funding Circle is a P2P lender in the UK that announced that it was reining in -riskier loans and cutting its expectations of revenue growth for 2019 from 40% to 20%. In FY2018, the company reported losses of £49.3 million. Funding Circle draws on a pool of funds collected from individuals and firms, which is then lent to small businesses vetted by the company. P2P lending was going to be the next big thing in small-business lending, filling the gap left after the financial crisis in 2008, when many banks sharply curtailed their activity.

Market watchers said the P2P lending idea was simple, and the general populace could support entrepreneurs and make money while doing so. MAS released an FAQ on crowdfunding (which is similar to P2P lending) in 2016. In Singapore, crowdfunding activities are regulated under the Securities and Futures Act (Cap 289) and the Financial Advisers Act (Cap 110).

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Funding Circle and other companies set up exchanges that matched lenders — often members of the public — with small businesses that needed money. It was hailed as a disruptive business model that would make life difficult for the big banks.

Because it cuts out banks, Funding Circle was billed as a disruptive force in lending. But in April, the company’s shares took a hit after it announced plans to wind down a fund that had financed a number of small business loans.

Lending Club lost US$128 million last year and has guided for a loss of US$29 million ($40.07 million) this year.

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As for small and medium-sized enterprises, most of the survey work done by International Enterprise Singapore shows that the availability of credit to local SMEs is high. But there are some micro SMEs that are underserved, so it is possible to build a business around that, Gupta reckons. But he adds:“Singapore is not a big market, not a big country. If you take any one of these pockets and ask how much money you could make doing this business, it does not give you room to grow and operate.”

Other digital models

Dennis Khoo, regional head of TMRW Digital Group at UOB, says the basis of banking is trust. “A bank is about reputation, trust, credit and risk management. It’s hard to be a bank; you are regulated and you can’t be that creative because of reputation. So, a fast-moving tech player is unlikely to want to be a bank.”

E-wallet players — such as WePay and Alipay — were successful in China because there was a large underserved and underbanked population. This was the segment in China that was not well served by the banks, so Tencent Holdings and Ant Financial (in which Alibaba Group Holding owns a stake) were able to do what the banks should have done, Khoo explains.

Another large country with a big unbanked population is Indonesia, which has provided Gojek with an opportunity to create an e-wallet (deposits and funding) to be used for services (transactions).

In small markets such as Singapore and Hong Kong, e-wallets have arisen out of convenience. For instance, commuters in cities such as Singapore are forced to use e-wallets to pay for transport, such as on the MRT. “Transit is a big-use case and the [wallet issuer/operator] can force you to use TransitLink [in Singapore],” Khoo says. He adds that Octopus in Hong Kong has evolved from being used to pay for transport to being used for retail purchases. More recently, credit cards can be used to “tap and go” on the MRT.

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Hence, for any of the Singapore wallet players to re-enact what Tencent and Ant Financial have done in China would be a challenge. Already, Singapore is seen as having too many e-wallets.

At any rate, from this year, the People’s Bank of China requires non-bank companies such as Ant Financial and Tencent to place their customer deposits under centralised, interest-free accounts with the central bank. Previously, Ant Financial and Tencent could deposit monies that were in the wallets into bank accounts to earn interest. PBOC has given a two-year window for all payment firms to complete the transition as it gradually raises the reserve funds ratio.

According to Chinese research firm -Analysys, Ant Financial and Tencent account for around 90% of China’s third-party mobile payments and 34% of all third-party, internet-based payments. “Payments is not banking,” Khoo clarifies.

That is not to say the likes of the two Chinese giants cannot regionalise. Tencent launched We Remit in 2017 to help foreign domestic workers send remittances to their home countries such as the Philippines and Indonesia. Its WePay is ubiquitous in China. In 2014, WeBank — backed by Tencent — became China’s first digital bank.

WeBank is mainly retail, while MYBank — backed by Ant Financial — serves small business owners, who are shunned by China’s brick-and-mortar commercial banks. MYBank focuses on simple loan and deposit products. Business solutions and products provider China Knowledge says China’s online banks have performed much better than traditional banks in terms of asset growth, balance sheet performance and non-performing loans (NPLs), but it is not clear whether they are profitable.

Ant Financial has tied up with CK Hutchison Holdings to launch a digital wallet. In June 2018, the partnership introduced a blockchain-powered cash remittance service that allows real-time transfers of cash between individuals in Hong Kong and the Philippines.

In Singapore, Oversea-Chinese Banking Corp (OCBC) is exploring ways of commercialising cross-border transfers using distributed ledger technology. It has already carried out DLT-enabled transfers to Malaysia with its subsidiary, and to the Philippines with Union Bank of the Philippines.

High standards to maintain stability

What would Singapore’s new digital banks look like? MAS is very clear — the digital banks, although not immediately profitable, may need to demonstrate a path to profitability. The conditions that applicants for its digital banking licences need to meet appear demanding.

Asked when these new digital banks could pose a challenge to the local banks, Srinivasan says: “Virtual banks will become mature and compete effectively against existing banks when they are able to effectively tackle unmet financial needs, and show that they have a sustainable and profitable digital banking business model.”

The challenge for the new digital banks is to find unmet financial needs. Gupta of DBS says: “We’ve addressed the pain points. We do instant everything: money transfers, payments, financial planning, wealth management, cards and so on. We have a very competitive product.”

The digital full-bank licence is open to companies headquartered in Singapore and controlled by Singaporeans. As long as a Singaporean party has the largest shareholding and management control of the digital bank, MAS will view the company as Singaporean. Foreign companies are eligible if they form a joint venture with a local company and the JV meets the headquarters and control requirement.

To be eligible to apply, the applicant or its parent group must (i) have a track record in operating an existing business in its respective technology or e-commerce fields (MAS will not consider applicants with no existing businesses); (ii) provide clear value propositions on how it can serve existing unmet or underserved needs; and (iii) demonstrate that it has a sustainable digital banking business model.

MAS will not allow any bank, digital or otherwise, to engage in value-destructive competition to gain market share. The central bank will assess the reasonableness of the applicant’s business plans and financial projections such as cost-to-income ratio and net interest margin. Gupta and Wee highlighted this point when asked whether they viewed the new digital banks as a threat.

Eventually, the digital full bank will need a minimum paid-up capital of $1.5 billion (see Table 1).

A digital full bank will be required to incorporate in Singapore, so that MAS will have stronger regulatory and supervisory oversight and, in the event of failure, offer better protection for depositors by enhancing the resolvability of the digital bank. The digital full bank will also have to comply with the same suite of prudential rules as incumbent banks, including ongoing risk-based capital and liquidity requirements; and submit a viable exit plan to facilitate an orderly wind-up if necessary.

Onerous capital and liquidity standards

The local banks, including the locally incorporated subsidiaries of foreign banks such as Citigroup, HSBC, Standard Chartered and Malayan Banking, are required to comply with certain regulations.

Although the Singapore banks are not G-Sibs, or global systemically important banks, as defined by the Basel Committee on Banking Supervision, the local banks, including the local subsidiaries of foreign banks, are required to follow MAS Notice 637. The banks have to disclose 12 indicators based on cross-jurisdictional activity, size, interconnectedness, substitutability/financial institution infrastructure and complexity on an annual basis, in accordance with instructions issued by the BCBS.

The minimum common equity tier 1 (CET1), tier 1 and capital adequacy ratios set by MAS as at Jan 1 this year under MAS Notice 637 are 9.0%, 10.5% and 12.5% respectively, and viewed as higher than those in other developed-market jurisdictions. Whether Singapore’s new digital banks are able to eventually comply with MAS’ ratios remains to be seen. As a strategy, the three local banks have articulated their aim to have a CET1 ratio of at least 13.5%, setting a high bar for the new digital banks.

The minimum leverage ratio set by MAS is 3%, and those of the three local banks are well above 6.5%. OCBC’s and UOB’s leverage ratios are 7.5% and DBS’s is 6.9%.

In addition, the local banks have to disclose their liquidity coverage ratios, net stable funding ratios (NSFRs) and leverage ratios on a quarterly basis. The LCR requirement is to ensure that banks have sufficient unencumbered high-quality liquid assets (HQLA) to survive a significant stress scenario for the next 30 days. The minimum regulatory requirement for LCR is 100%, and those of the local banks are comfortably above this threshold. The local banks disclose their Singapore dollar and all currency LCRs quarterly. Whether the new digital banks have to comply with this requirement remains to be seen.

The NSFR requires banks to fund their activities with more stable sources of funding on an ongoing basis and is the ratio of total available stable funding (ASF) to total required stable funding (RSF). BCBS requires the ASF-to-RSF ratio to be more than 100%.

The requirement to meet the NSFR and LCR arose after the global financial crisis, when US and European banks fell short of funding and capital and had to lean on shareholders and new shareholders such as sovereign wealth funds.

If, as Gupta has suggested, the new digital banks have to play in the very high-risk segment of the market, capital and liquidity are likely to be closely watched.

“Success is not guaranteed [for virtual banks] unless these new banks are able to transform into data-driven, high-performance and profitable organisations,” Srinivasan says.

Looking for a partner for wholesale banking

Khoo says the digital wholesale bank -licences are more interesting (see Table 2). This is because in the SME space, data plays a big role in credit analysis. “It’s hard to find one place where you have all this data, and the marketplace is interesting because of companies that hold a lot of accounts receivables and payables,” he muses.

If digital banks are able to bank more SME players, the opportunity to extend credit to these players exists. “We can set up a separate entity and compete in this space,” Khoo points out. “The [new digital bank] licence is for [Singapore-based] businesses. We are not taking any option off the table. If we have the right partner, we will evaluate applying for a licence. If we want to, the regulation allows a local bank in Singapore to set up a separate entity to compete digitally, using the same licence and leveraging the same capital.”

As far as Singapore is concerned, though, Khoo says one of the constraints is the size of the local market. “In Singapore, only 2% of the [resident] population is unbanked. So, it’s going to be difficult to find [growth opportunities], and that is the major consideration of most people when applying for a licence. Standards here are also quite high.” He is referring to the current capital and liquidity requirements for the digital bank aspirants. UOB rolled out its own mono-channel digital bank, TMRW, in Thailand in March, targeting young professionals (see “Banking for TMRW” on Page 23).

Gupta of DBS is similarly frank about the challenges that potential new players will face. “So far, I’ve not seen any evidence of revenue streams from digital banks anywhere in the world. Only Ant Financial has a consistently strong revenue stream. In China, it has tapped a lending market and is funding people who do not have basic banking facilities. Moreover, there are no lending restrictions in China in that regard. In Singapore, MAS imposes restrictions on unsecured lending to consumers, and it is a small market,” he explains.

“You might argue that there are opportunities in microfinancing, but I’m still looking for some good cases. Every banking revenue stream comes from raising money, moving it around more intelligently and charging fees along the way. Can I charge fees by being more efficient in the way I move money around or raise capital? It’s not clear where the big opportunities to create revenues are."