Rising interest rates births more challenges for Asia's digital banks

Few manage to break even, and those that do are back by conglomerates.

Asia Pacific's digital banks will find achieving financial viability more challenging now due to increasing interest rates and tightening funding conditions.

It’s a matter of how much risk they’re willing to bet on in order to rake in more profits, according to Fitch Ratings analysts Tamma Febrian, Elaine Xu, and Matt Choi. These banks net interest margins will be influenced by their risk appetite.

“In general, we believe the best opportunities for digital banks in APAC are in markets with larger unbanked populations. However, lending to underserved sectors carries higher risk, with their lower income and limited credit history posing key challenges for digital banks trying to crack the market,” Febrian, Xu, and Choi warned.

They added that they expect credit costs to rise more significantly for these segments in a higher-interest-rate environment.

A softer economy could also affect the banks' target customers disproportionately, raising asset-quality risks, they added.

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APAC countries have recently been engulfed by a digital banking spree. In late 2020, Singapore handed out licenses for virtual-only banks, with the winners just having kicked off operations in mid-2021. These include two wholesale banks, Green Link Digital Bank and ANEXT Bank; and GXS Bank, a retail digital-only bank backed by Grab Holdings and local telecommunications giant Singtel.

In Indonesia, the regulator opted to change banking rules to allow for digital-only banks; whilst Malaysia also recently granted five digital-only bank licenses, with GXS Bank notably obtaining one of the licenses as well.

A Path To Profitability
Making a profit will also be increasingly challenging for many digital banks in APAC, Febrian, Xu, and Choi said. The viability of digital banks is highly influenced by the size of the market, local industry competitive dynamics, the strength of their franchises, and the banks' strategy and ability to execute it. 

Many leading digital banks in APAC are sponsored by established corporations or are a part of a consortia, whose existing vast customer base provides critical mass for these banks to quickly scale their business.

But having a complementary ecosystem and leaner cost structure may not be enough for these disruptors to start making a profit.

“For example, all of Hong Kong's digital banks remain in the red even after three years of operations, although most are owned by conglomerates or established corporations, in part due to continued investments as well as the industry's highly competitive market,” the analysts said.

For the analysts, a key factor to the success of the few profitable digital lenders in APAC was their ability to identify lucrative niche segments. Parent linkages massively helped the quest for profitability for most banks, with banks in emerging markets recording shorter lead time, they added.

Success would take time. On average, profitable digital banks in APAC still took, on average, around 2-5 years for them to break even, according to Fitch. Most are located in East Asia, of which three are in China (aiBank, WeBank, and MYBank), three in Japan (Rakuten Bank, Sony Bank, Lawson Bank), and two in South Korea (K Bank, Kakao Bank). Of these, Rakuten Bank took the longest, at 7 years.

The lone non-East Asian digital bank now making a profit is Indonesia’s Jago, which broke even in just a year since its launch.

“Indonesian bank Jago's ability to break even only about a year after Gojek raised its stake in the bank highlights that profitability may be more readily attainable for those operating in less-banked markets with wider margins and less cutthroat competition,” the analysts said.