‘Virtual Banks popular among tech savvy customers’

Virtual banks, which are often used interchangeably with Neo Banks, are essentially a form of a direct bank, which delivers banking services sans a physical branch. They use the Internet and multiple other electronic channels to provide a more personalized and fully digital banking experiences and are currently the most popular among tech savvy customers.

Virtual banks do not offer in branch services that traditional banks offer, they instead provide their re-engineered services through a channel such as a mobile application throughout the day. Therefore, for example a bank deposit that would require you to go to a traditional bank during banking hours, could be done with a few clicks through your virtual banking platform at any time of the day.

In this sense, virtual banks share a similar characteristic with a traditional bank that has a digital banking unit. However as opposed to a digital banking unit, which is run through an established traditional banking parent, a virtual bank might not have an office or building of it at all, operates independently and at most instances solely digitally.

Virtual banks also tend to offer certain additional features to their banking products to attract customers from the traditional banking institutions, such as saving products, spending goal notifications etc.

The main difference that is important in Virtual banks is the cost savings that it offers due to having limited overheads, due to not having to pay large rent, salaries and charges to employees or branches. Due to this, virtual banks are able to provide their services at relatively low fees, and also transfer the cost savings they have gained to the customers in terms of high interest rates on savings products, low commission rates and low interest rates on loans.

Why do we need Virtual Banks?

Virtual banks are characterized by their low cost structure, and ease of access due to operating through electronic channels. Both of these features make virtual banks an ideal solution for the under banked and unbanked population, as virtual banks provide affordable financial services, and will be dealing with the customers through a digital platform, their cost of servicing each customer would be minimal as opposed to a traditional bank operating through a branch.

Virtual banks also bring competition to the highly concentrated financial services industries in many countries, as the big banks in most countries operate in monopoly like conditions and charge high rates and fees and continue to profit massively.

Another reason as to the gaining popularity of Virtual banks is their great digital experience offered. As virtual banks provide their services mostly through electronic platforms, they tend to invest a lot of resources and time into refining their digital products, hence they end with very interactive and easy to use applications and platforms, that performs complex activities much conveniently.

Virtual banks are required to be more transparent with their charges and how they operate in general. Due to these banks not having large establishments or a long-standing brand name they need to win the trust of the customers gradually. Hence the virtual banks are very less likely to have a surprising exorbitant overdraft penalty or excessive late fees without notifying the customer about it earlier.

Virtual Banks’ Landscape

Named as challenger banks, neo banks etc. virtual banks have been disrupting small traditional banks in most countries. Seeing this trend, Monetary Authorities of a few countries have initiated to give out virtual banking licenses as pilots as well.

As per a report cited from research firm ‘Analytical Research Cognizance’, Asia-Pacific is the leading/significant region across the world in terms of market share due to favorable government regulation and Growing investment in financial technology in the region.

Europe is estimated to grow at stable growth rate in the global Neo & Challenger Bank market over the upcoming years. Further, North America is anticipated to exhibit a higher growth rate / CAGR over the forecast period 2018-2025.

The following are a few of the large neo banks and challenger banks that have captured a sizable market.

UK

The UK has seen the rise of a number of virtual banks with new features being added to their products regularly. Atom, Monozo, Starling bank, Revolut and Curve are a few of the mains.

Hong Kong

The Hong Kong Monetary Authority recently granted 8 virtual banking licenses with the intention of revolutionizing their banking and finance industry. The eight licenses were granted out of sixty firms that applied for it. A few firms that were granted the license are, Ant SME (A fully owned unit of Ant Financial), Insight Fintech (A JV between Xiaomi and AMDT group) and Infinium (A JV between Tencent, Industrial and Commercial Bank of China)

As opposed to the stand-alone fintech firms that carried out virtual banks in other countries, it can be seen that a few of the largest tech giants have paid attention towards the concept of digital only banks.

Singapore

Following the issue of the virtual banking licenses by Hong Kong, Singapore also announced their intention to issue five digital banking licenses including two full digital banking licenses, and three digital wholesale licenses.

In Singapore’s case, the intention of the Monetary Authority is to implement the Digital banks to serve the undeserved segments such as small businesses who are currently unbanked.

US

The US houses roughly over 11,000 registered banks and credit unions and also has seen quite a large number of digital only banks registered within it as customers have shifted towards banking either online or through their smart phones. A few of the largest to state are, Ally, Chime and Discover bank.

In the majority of these countries, the Virtual banks are subject to the same set of regulatory procedures as traditional banks. In addition, a few countries such as Hong Kong have restricted certain activities of the banks, until they meet certain criteria, thereby keeping adequate provisions to maintain the stability of the financial system.

The Sri Lankan Context – Virtual and Digital Banks in Sri Lanka

Sri Lanka to-date doesn’t house any virtual banks due to the regulations not allowing them to be created. What we do see in Sri Lanka however is a banking industry that’s evolving at a fast pace to be increasingly digital.

As customer behavior changes with the ever-evolving digital technology, banks have been burdened with the need to create new experiences to its consumers to retain them and be in business. This has resulted in banks investing heavily into digital transformation, without looking into the real benefits or the use case of them and in some instances creating multiple applications with duplicating functions, only to compete with a similar application of a competing bank.

Currently, in terms of digital banking, the applications Frimi by the Nations Trust Bank and Flash by Commercial Bank appear to be in the forefront in terms of functionality and features, and are closest to what a virtual bank would provide to its consumers.

The Sri Lankan banks aren’t going to reap the benefit of going digital in the near future, as the customers themselves are still getting used to the concept of Digital banking yet. Though the customer account based mobile payment transactions have grown almost 4 fold YoY in the previous quarters, the customer adoption of digital banking as a whole in Sri Lanka is lagging.

However the seamless plans of large banks of Sri Lanka looking to consistently innovate and making going digital a priority might make the future of the digital banks brighter into the future.

Future Of Virtual Banks

As financial inclusion is promoted in many countries to a large extent, the scope that fintech has in the financial industry has been growing continuously. Virtual banks pose a viable solution to most of the under banked segments due to it’s nature of affordable financial services, that can cater to large masses with low transaction values. In addition to this, as virtual banks are not expected to impose minimum account balances or charge low balance fees it’s more suited for the under served segment in any market.

Virtual banks however faces one challenge of not being able to build up the emotional connection that a traditional bank does over the counter by having the human touch. That too, in most occasions is appealing to the older generations that wouldn’t be savvy enough to communicate using the chat bots or the in app support services. Given the level of technology requirement and investment needed for a virtual bank, it does require expertise in management greater than a traditional bank to some extent. As the technology related risks, and information systems related risks need to be well managed in a virtual bank.

These risks also do apply to a great extent to a traditional financial institution, however in this case, the damage that can be caused by a cyber intrusion or technical failure is much aggravated due to not having a fall back method of servicing customers.

Virtual banks however can’t be expected to disrupt traditional financial institutions in the short term, for a number of reasons.

The first being that the Monetary Authorities of most countries have stringent controls in place to ensure that disruptive business models do not get approved, as the value destructive competition to gain market share could result in the loss of value in the industry and also brings instability to financial system.

The second being, the traditional financial institutions that have been operating also have the ability of creating digital only banks and operating them with the backing of their long respected brand name at similar rates and charges, hence they have the ability of regaining any market share that’ll be targeted by the new fintech firms.

These new virtual banks however will create competition for the small foreign owned incumbent banks, which do not have a sufficient client base to introduce digital banking products as opposed to the investment it would take them.

Going forwards, the virtual banks will prove to be a viable solution to the large costs paid by traditional banks in terms of large front office staff salaries and large building rent and other expenses.

Large banks continue to charge high commission rates and fees on most services to date, regardless of the fintech firms that have tried to disrupt them in the spheres of payments and remittances.

These virtual banks would give more secure and cheaper alternatives to customers and at the same time reduce the wait time to be served, hence it’s a matter of time that we see the banking landscape to slowly tilt to be digital.

The writer Shehan Senanayake is a Fintech analyst attached to Emerging Markets FinTech, a Singapore based company planing to open in Sri Lanka.