The adoption of digital technology had been accelerated by several years because of the pandemic. For example, Global internet and active social media users had increased by 7,3% and 13,2%, respectively in 20201. This accelerates the shift in customer preference that had been moving to digital even before the pandemic. Banks are also impacted by this shift, as many existing traditional banks are trying to improve their digital services to comply with the changing consumer preference. On the other hand, pure digital banks with heavy technological value propositions and few physical branches are primed to utilize this change to further their businesses.
As the digital banking market continues to expand, its importance and impact in the overall banking landscape, as well as the global economy would continue to increase. This article aims to explore the concept of digital banking, what drives its growth and what are its main advantages compared to its traditional counterpart. Also, there are 2 specific subset of Digital Banks which are focused here, both which have a substantial digital market. The first one is Islamic Digital Banks, which are essential as a subset that serve the second largest religion in the world with a young median age. The second one is Digital Banks in Indonesia, which have a huge digital market and a growing digital economy.
Digital banks have been blossoming all over the world, with more than 200 new digital banks established globally since 20102. China’s WeBank is the largest digital bank in the world by user base, with 270 million users3. The global digital banking market is estimated to be US$12,1 billion in 2020, and is projected to reach US$30,1 by 20264. As mentioned before, the pandemic has had an important impact on digital banking, as social lockdowns and health concerns make digital banking services no longer optional5.
The Indonesian Financial Services Authority (OJK) defines a digital bank as a bank which provides and runs its business primarily through electronic channels without a physical office outside its head office, or using limited physical offices6. This definition bases a digital bank on its channels and its offices. This means that a digital bank is not merely a bank with online features, but ones which have an entirely digital experience.
According to Forbes, digital banking is a banking service which combines online banking and mobile banking service, which is a broader definition7. DS Innovate describes digital banking as an end to end fully digital bank product and services, which is a higher technological level than mobile and internet banking8. According to BCG, some of the key unifying traits of digital banks are a branchless design,superior customer experience, and use of technology2.
Compared to traditional banks, a digital bank has many advantages, including the following:
- Less increase in costs as it grows, because it does not need to maintain many, or even any physical branches3.
- A strong data integration would allow a better risk model, more operational efficiency,and better customer targeting.
- Efficiency and the use of customer data would allow digital banks to serve more customers than traditional banks.
- A better user experience through digital features and a user-friendly interface
- A potentially lesser margin due to efficiency
The accessibility of digital banks are a significant factor of its rise2. Digital banks can give affordable services to underbanked segments, which is a major benefit in several regions such as Southeast Asia. These banks can give better access to many banking services such as accounts, payment channels, and credit cards. The use of technologies would also help banks overcome information asymmetry needed to screen customers, such as using big data, AI/ML (Artificial Intelligence/Machine Learning), and blockchain9.
Digital bank customers would have a more user friendly interface and a higher level of service. This results in a better experience, with features such as lack of hard copy documentations, adaptive credit limits, and instant chatbot feedback. The technology used in digital banks can give more personalization to products, such as smart saving solutions. Digital banks generally also have more innovating capacity, as they are not weighed down by legacy technologies and generally have a more efficient operational design and a smaller firm size.
Even though there are numerous advantages in digital banking, it still has inherent risks, especially in consumer protection2. For example, as a tech-heavy industry, cyber attacks and data protection is a significant concern regarding customers, and this can lead to larger systemic risks. Furthermore, as digital bank founders may lack a banking background, they may lack understanding of the existing market risks.
Moreover, the sustainability of the sector is rightfully questioned, as according to BCG, only 7 out of 150 digital banks in developed markets generate profit2. Many players base their success on metrics which may not translate to financial sustainability, such as valuations and app download. In order to be sustainable, digital banks need to combine fee-based and margin/interest-based revenue streams with lower cost structure, utilizing an app-centric, branchless approach and a lack of legacy IT infrastructure.
As previously mentioned, one important aspect that pushes the transition to digital banking is the shifting customer preferences which is accelerated by the pandemic. Survey from PwC10 shows that the most important factor for a client to switch banks is poor mobile platform, which shows that digital experience is the primary driver for customers, ahead of traditional factors such as prices or customer service. The pandemic also forces people who use cash payment methods to adopt digital payment, and this adoption seems to be permanent, as according to a survey from Visa, 68% SMEs would permanently change their payment method post pandemic11.
Furthermore, the aforementioned PWC survey shows that 32% of banking customers want to avoid going to branches, up from 26% in 2021, while branch dependent customers dropped from 42% to 35%. But this survey also shows that physical branches still have importance, as more than a third of respondents stated that they would not use a bank without a nearby branch, and two-thirds think that physical branches are a meaningful channel of interaction.
An interesting case study of digital bank is Nubank, a Brazilian digital bank which is the highest valued digital bank in the world12. Since its first launch in 2014, Nubank has averaged almost doubling its number of customers and revenues yearly, even though Brazil has a highly concentrated banking industry. What works in their favour is that Brazilian banks have a large interest spread, complex bureaucracy, and bad customer service, which gives room for digital banks to give digital solutions.
Using technology, Nubank is able to onboard a new customer in 5-10 minutes, while traditional banks need 5-10 working days. Their customer experience is also top notch, utilizing excellent customer service, quality delivery boxes, and an intuitive online app to remove friction and offer a consumer centric product. Its own cultural values of customer centrism, team autonomy, and ownership is an important factor in its growth. However, as they focus on growth, Nubank is yet to be a profitable bank, which highlights the sustainability concerns mentioned earlier.
Islamic Digital Bank
The growth of digital banks, and digital banking services, are also happening in the Islamic Banking landscape, as changes in customer preference and the pandemic drive this change globally. An IFSB13 survey shows almost every existing Islamic banks are in various stages of digitalization, many being forced by the pandemic. Pure digital Islamic banks have also emerged in several countries, including the UK, Indonesia, and Germany.
Digitalization in Islamic Banks would give a similar impact and benefits to its conventional peers. This includes better insights from data, enhancing financing access to MSMEs, improving compliance and risk management, and promoting financial inclusion13. Muslims are also an especially strong digital market, with a young median age and good smartphone penetration. Furthermore, many muslim countries has a substantial unbanked population, which serves as potential market for digital Islamic banks.
On the other hand, there are also similar risks in digital Islamic banking, which includes cyber security, money laundering, AML/CFT (Anti Money Laudering/Countering the Financing of Terrorism), issues, and customer protection. Specifically for Islamic Banks, Sharia Compliance risks regarding digital activity can arise, as there might be issues in fulfilling specific characteristics of Islamic contracts digitally, especially if there are errors or malfunctions.
One example of a standalone fully Islamic digital bank is Rizq from the UK. Rizq offers the usual digital bank features, such as quick account creation and online banking, and promotes being free of interest as their value proposition. On the other hand, existing Islamic Banks are also creating digital subsidiaries, such as Boubyan bank’s Nomo in the UK and al Baraka’s Insha in Germany14. In UAE, Rizq/Baraka digital bank has been announced by Zurich Capital, aiming for customers in the Middle East and North Africa.
Digital Bank Developments In Indonesia
Indonesia has more than 200 million internet users and a quickly developing digital economy sector, making it a substantial area to be highlighted. According to survey data from Mckinsey, 78% of Indonesians currently use digital banking, a substantial increase from 57% in 201715. Furthermore, role of physical branches are diminishing, where only 55% of Indonesians visited a bank branch monthly, dropping from 81% in 2017.
Data shows that the Indonesian digital banking market still has a significant growth potential. According to the previous survey, 47% of Indonesians are open to moving their accounts to digital-only banks. Currently, according to finder.com, 25% of Indonesian adults have a digital bank account in 2021, and is projected to rise to 39% in 202616. This figure is globally second only to Brazil, which is home to the aforementioned NuBank.
According to Momentum Momentum Works17, The digital banking market in Indonesia can be divided into 3 categories. Firstly, traditional banks which have online features, who incorporates mobile banking features to accommodate transactions and manage accounts. The second one is a pseudo digital bank, which is an online product option of commercial banks, with the same system from their main offerings. Thirdly are pure digital banks which fully rely on online processes in a customer’s life cycle.
More specifically within the digital bank market, there are 3 types of players with differing resources17. First one is local banks, such as BTPN’s Jenius, with local knowledge who want to go past their peers before disruptions. Second one is regional banks with established brands, such as UOB’s TMRW who wants to grow in Indonesia. And the third one is tech or fintech players with tech resources, such as Gojek with Bank Jago, who want to strengthen their ecosystem.
The new Indonesian banking rules allows almost full foreign ownership, which allows many partially foreign owned digital banks to operate18. This rule also gives banks a quicker permit process for new services. However, capital requirement for a digital bank is still the same as traditional banks, which is very high, amounting to almost 30 times the amount of Malaysian digital banking capital requirement19.
In Islamic Banking, accelerating digitalization is part of the development roadmap by the Indonesian Financial Authority20. Digitalization is stated to be important to face challenges from rapid technological advancement, creating better and more convenient services to customers and adding value to them. Currently, there are not yet existing Islamic Banks that launch a pseudo digital bank, as they are mostly focusing on improving their online features.
Beyond existing banks, there are also pure Islamic digital banks, such as Aladin and the soon to be released Hijra Bank. Hijra Bank, which is a part of Alami Group, also serves many of the regular services of Digital Banks, such as quick online registration and excellent customer service. However, it has several innovative features which differentiate it from others, such as Hijra Box, a feature to ease financial management and many Islamic worship-based features.
The evolution of banking seems to be heading towards digital banking, both in the form of digital services of traditional banks and pure digital banks. Using technology, digital banks have many advantages compared to traditional, such as accessibility, data, cost, customer service and others, however, it still has several risks, especially in consumer protection. We also see this trend in Islamic Banks, which would get similar advantages and risks to conventional banks by digitizing. Lastly, Indonesia is a large and developing market in both conventional and Islamic digital banking, with many entering players and governmental support pushing digitalization.