Fintech challenge is a fantasy

News: The government is poised to launch 75 digital banks soon.

What will be launched are Digital Banking Units (DBUs). These are a new way of making available digital products of existing banks and non-banking financial companies (NBFCs).

If one thinks that a sleek set of new banks is going to challenge traditional banks, one is mistaken.

What are Digital Banking Units (DBUs)?

These are the outlets where people can avail of banking products, mostly on their own.

There will be personnel to assist them, but these will be kept to the minimum.

In other words, a DBU can be seen as a branch that operates mostly in a digital (or paperless) mode.

DBUs are one way in which digital products can be offered. In this model, the digital products stay within the bank.

What are the advantages offered by DBUs?

By eliminating paper, DBUs can reduce processing time and help enhance employee productivity.

What are the challenges?

Even highly literate customers prefer the convenience of walking into a normal branch to meet many of their banking needs. To suppose that in under-served areas, people will be able to help themselves to any but the most basic banking products (say, deposits) is a stretch.

DBUs may be able to grow deposits quickly, but they are unlikely to be able to do much on the asset or fee income side.

What are Neo-banks?

Digital products can also be offered through digital banking subsidiaries or by standalone digital banks (neo-banks)

In the late 1990s and early 2000s when online banking came into fashion abroad, banks did experiment with digital banking subsidiaries. These did not work and were subsumed into the parent. Standalone banks based on internet banking did not survive either.

Standalone digital banks have made a comeback, thanks to the mobile phone. They are part of the broader category of players labelled fintech.

What are the various ways in which fintech can happen?

Fintech, which is the provision of financial products through electronic platforms, can happen in three ways.

One, through entities that compete with banks (such as digital banks).

Two, through entities that collaborate with banks by providing a range of services, such as customer acquisition, KYC checks, loan processing and screening, loan collection, risk management, customer management and so on.

Three, through entities that eliminate the need for financial intermediation, for example, peer-to-peer lending platforms.

Are digital banks a threat to traditional banks?

Unlikely. These banks do not target traditional banks head on due to the following factors:

Digital banks take higher risks and are often suffer from poor margins and profitability.

Target different customer base: Digital banks typically target high risk customers that banks tend to avoid. These include: a) Individuals with lower incomes or lower credit scores, b) commercial real estate and c) unsecured lending.

Digital banks’ potential for fee income is lower because they deal with lower income clients.

High marketing expenses: What they save on non-establishment of brick and mortar branches is more than offset by huge marketing expenses. Not surprisingly, most are loss-making.

Centrality of bank branches: The experience of the past two decades suggests that the centrality of the branch to banking remains. Digital banking cannot wholly substitute the branch when it comes to customer acquisition. It is a tool for customer retention, an added service that banks provide by way of holding on to customers.

Banks have always adapted to the challenges thrown at them by competitors, like NBFCs and fintechs. They have evolved their business model by providing high-yielding products that the competition is offering, or acquiring the competition altogether.

Hence, the notion that fintech will displace banks is a fantasy. Banks will imitate fintechs or swallow them, they aren’t going to disappear.

Way forward

Digital banks are lightly regulated at the moment. They are a threat, not so much to banks, as to banking stability on account of the systemic risk they pose. Hence, they need to be regulated tightly.

Source: This post is based on the article “Fintech challenge is a fantasy” published in The Business Standard on 9th June 22.

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