Singapore can finally wield UK’s digital banking dagger
Updated: Jan 21, 2020
Traditional banks’ fall from grace
The tumultuous past that has haunted traditional banks since the 2008 financial crisis has never truly settled. More than a decade later two thirds of British adults still do not trust banks to work in the best interests of society. Exacerbating this abysmal confidence is the sharp rise in the number of cybersecurity incidents declared by traditional banks and financial services firms from 69 in 2017 to 819 in 2018 – a spike of more than 1,000%.
Prior to this, setting up a new bank with a full UK banking licence was both expensive and time consuming. Consequently, a very small number of banks - the Big Four - dominated the UK banking market which had virtually no competition. Indeed, when Metro Bank received their license in 2010, it was the first one to have been issued by the UK government in 100 years.
In the wake of the 2008 financial crisis, a decision was made to open up the market to new banks. After a period of consultation, the regulation to enable this formed part of the Financial Services Act 2012, which came into force on April 2013. More recently, the Payment Services Directive 2 (PSD2) from January 2018 reduced barriers to entry to the banking industry across Europe. In particular, PSD2 enabled third-party access to account information, permitting new firms to access customer data (previously only available to traditional banks) which they can now use to contact customers to gain business.
In removing two long-standing barriers to entry – access to bank data, and payments infrastructure – the directive emboldens disruptors further, enabling a variety of new business models that cut across industry lines and provider types.
The combination of a historic trough in consumer confidence and the recent opening of the financial regulatory landscape has created a rare opportunity for new entrants to capitalise on a once thought impenetrable market.
Rise of digital banks
Over the past year, so-called challenger banks and Neobanks (digital-only banks) have been making headlines by attracting big venture capital investments. Six challengers are already worth more than $1bn in total (Brazil's Nubank $10.4bn, US' Chime $5.8bn, Germany's N26 $3.5bn and UK duo Monzo and Revolut at $2.5bn and $1.7bn respectively). Monzo, UK’s fastest-growing digital bank, is weeks away from raising fresh funds of between £50m and £100m in a deal that could precede another big investment round later this year.
Neobanks continue to make a significant impact on the financial landscape. One reason they have grown so quickly in the past few years is that they often provide consumers with innovative services at very attractive fees and rates. But is this business model viable in the long run?
Accenture research estimates that the average UK Neobank loses $11 per user annually. At first glance, this should be of concern – significant activity but little value creation is the same situation that preceded the bursting of the .com bubble. However, this statistic fails to tell the full picture. Research indicates Neobanks have much lower acquisition costs, perhaps as low as 1/10 of the acquisition cost of a traditional high street bank. Operating costs per customer are much lower as well; the average yearly operating cost per customer of a Neobank in the UK is around $25-$63, compared to over $210 for a traditional bank.
Even though traditional banks still have the highest install penetration rates in the UK, they are increasingly losing relevance in the mobile banking space. Two, in particular, have experienced declines in the past year: NatWest fell from an install penetration of 8.8% in 2018 to 8.3% in 2019 and RBS from 2.0% to 1.8%.
Meanwhile, Neobanks are experiencing rapid growth in install penetration. Monzo, a four-year-old Neobank, rose from an install penetration of 2.0% in 2018 to 5.1% in 2019 (YoY growth of 151%). Similarily, Starling Bank, the oldest Neobank, founded in 2014, had an install penetration of 1.0% in 2018 and advanced to 1.9% in 2019 (+97%), and Revolut, a popular challenger that offers banking and debit card services, rose YoY by 67% to a 3.2% install penetration rate in 2019.
The Neobank allure
Why are Neobanks so attractive? Below are some of the key factors leading to their popularity:
1. The Fees – Neobanks require minimal overheads to operate (website maintenance) meaning they can price more competitively than traditional banks.
2. Functionality – Traditional banks’ mobile banking apps have been consistently criticised for being anti-user friendly. They frequently crash and are riddled with security concerns. On the other hand, Neobanks can offer a sleek, secure and easy to use service. The reason why Neobanks can offer a more secure service is a result of culture; they focus on securing data using technology and quickly adapt to the latest threats. Whereas, traditional banks are less tech-orientated and as a result, are significantly slower at adapting to change.
3. Wider Customer Base – As the barriers to entry to set up a Neobank are significantly lower than that of a traditional bank, they can afford to accept customers with poorer credit ratings than that of a traditional bank.
4. Easy to Set Up – Neobanks offer a streamlined paperless sign-up process, as opposed to having to go into a branch to set up an account. For instance, N26 paperless sign-up process takes up to eight minutes and can be done entirely from your smartphone.
5. Special Features - Many Neobanks offer built-in budgeting and saving tools within the account. For instance, Monzo’s target feature allows users to set budgets, categorise expenditures and receive live updates on the rate of their spending.
Traditional banks aren’t all that bad
With all that being said, incumbents do have a number of strong advantages over digital-only banks. The first is its brand value and specifically the amount of consumer trust this brand possesses. Second is the finance at their disposal.
A further disadvantage of digital-only banks is that, by their nature, they do not offer the full range of banking experiences that a high street branch can offer. In some countries this may not matter; in the UK for example, 72% of consumers do the majority of their banking online. However, whilst this remains the case there is an argument that Neobanks will remain only a second banking option, and not the primary banking services provider for the majority of consumers. And nowhere is this truer than in countries or regions where cash is a cornerstone of the payments landscape. As such, many customers run two accounts in tandem. Salaries are dropped into the main ‘pot’ while mobile-first banks are often used for everyday budgeting and easy peer-to-peer transfers.
More importantly, digital banks’ absence of retail outlets catalyse the problem of a lack of face-to-face interfacing with users and hardly any personal relationship with consumers. In the past few months, complaints from previously happy Monzo customers appear to have grown alarmingly, at a time when the bank is trying to get more people to go “full Monzo” and use its service as their main current account. Resolver, the independent online complaints resolution service, received more than 700 complaints in a little over a year, which it describes as a surprising number for a relatively new business. The majority have come in during the past six months. In a third of those cases, its users are specifically saying that their account has been frozen or shut down.
Upcoming regulations on digital banking
Despite the headwinds faced by digital banks, national regulators are relaxing licensing conditions. The Bank of England has introduced an expedited two-step process, in which start-up banks get a preliminary license to work with a small group of customers while providing regular reports. If that goes well, they are granted a full license within 12 months.
Hong Kong granted four new virtual bank licenses for the first time ever in 2019. Singapore is now following suit.
The future of digital banking – Singapore
Look no further than Singapore for headline news of a major disruption on its financial services industry. The Monetary Authority of Singapore (MAS) announced in June last year that it will grant five virtual banking licenses. Bidding ended less than a month ago and MAS said it will announce the successful applicants in June 2020. In the days that followed, several contenders started revealing themselves. Although MAS has received 21 applications for the digital bank licence, only a few applicants chose to make it public.
Here is the list of companies/consortiums which announced their applications:
Grab and Singtel; Razer Youth Bank; Beyond Consortium; Ant Financial; iFast Corporation; Hande and Yillion; Sheng Ye Capital, Phillip Capital and Advance.AI; AMTD, Xiaomi Finance, SP Group and Funding Societies; Sea Group; and Enigma Group.
Two of the five new licenses will be for the full range of retail banking services (digital full banking (DFB) licenses). This means that, for the first time in Singapore, non-traditional banks will be able to accept deposits from and provide financial services to retail customers. The remaining three licenses are intended for wholesale banking (digital wholesale banking (DWB) licences).
The DFB licence will allow for the consortiums to lend money to other companies and individuals, as well as serve retail customers. DFBs can take deposits from and provide banking services to retail and non-retail customer segments. Foreign companies are eligible if they form a joint venture with a Singapore company and the JV meets the headquarter and control requirements.
As for DWBs, they are only allowed to serve SMEs and other non-retail segments. DWBs will be allowed to take deposits from and provide banking services to SMEs and other non-retail customer segments. Both local and foreign companies can apply for this.
This move by MAS is a step towards further liberalisation of Singapore’s banking industry, in view of the ongoing digitalisation of finance. Allowing the entry of new digital players is intended to help:
1. Diversify and strengthen Singapore's banking system in the digital economy of the future;
2. Cater to under-served market segments using innovative business models and strong digital capabilities; and
3. Provide impetus for existing banks to continue augmenting the quality of their digital offerings.
The restriction on the number of new licences (in particular, in relation to digital full banks) has been imposed as MAS intends to retain a strong local core in the Singapore banking system, so as not to fragment Singapore's domestic retail banking market. MAS is also mindful of avoiding an unintended unilateral liberalisation of the full bank regime in Singapore, as a result of its World Trade Organisation commitments. The desire to ensure high-quality applicants and mitigate the risk of untested business models and cost of any failures has shaped the baseline requirements of, and safeguards imposed under, the new digital bank framework.
Eligible applicants will be assessed for the following:
1. The value proposition of the applicant’s business model, incorporating the innovative use of technology to serve customer needs and reach under-served segments of the Singapore market that differentiates it from existing banks. MAS will also consider the ability of the applicant to implement the proposal. Digital banks should therefore operate more nimbly using new technology stacks with a lower cost structure than traditional banks.
2. Ability to manage a prudent and sustainable digital banking business, including the level of understanding of key risks in the banking business, and strength of its regulatory compliance and risk management plans. MAS will also consider the reputation, track record, financial strength and commitment of the applicant’s shareholders.
3. Growth prospects and other contributions to Singapore’s financial centre, such as the jobs it will be bringing to Singapore, its commitment to develop the skills of the local workforce, the capabilities (including technology) it will be locating in Singapore, the headquarter functions it will be anchoring here as well as its regional expansion plans.
 Barclays, HSBC, Lloyds Banking Group, and Royal Bank of Scotland Group
 Directive (EU) 2015/2366 of the European Parliament and of the Council of 25 November 2015 on payment services in the internal market
 Note: the faster growing new digital banks in the UK – Revolut, Monzo, and N26, with three million customers combined – all used the two-step process. The slower growing three – Tandem, Starling and Atom – all waited two years before receiving their charters, then launched
 Grab and Razer, though separate applications, will be discussed together further down in the analysis