Due to the impact of COVID-19, digital banking is expected to rise and transform the financial service industry in Malaysia. This requires digital banks to comply with the digital banking framework issued by Bank Negara Malaysia (BNM). But what is digital banking, how does it work and are businesses and consumers ready for it? Read this article to find out.

Though digital disruption of the banking industry is inevitable – the COVID-19 crisis has turned into an unlikely catalyst to spur the adoption of digital banks in Malaysia. 

But what are digital banks? It’s easy to misconstrue digital banking as online banking, especially because all banks employ some form of digitalization – but digital banking is not equivalent to online or mobile banking. Instead, digital banking is the digitization of all traditional banking activities and services that have historically been available to customers when physically inside a bank branch.

With digital payment expecting to reach over US$1 trillion (RM4.2 trillion) by 2025, according to a Google-led study, regulators in countries across Asia are now pushing towards digital banks by either issuing or planning to award new licenses for digital banks. Closer to home, Bank Negara Malaysia (BNM) is set to issue up to five licenses to successful applicants to establish digital banks that conduct either a conventional or Islamic banking business. 

A 2018 McKinsey’s Asia Personal Financial Services (PFS) survey reveals that digital banking penetration has grown 1.5 times to 3 times in emerging Asia since the last survey in 2014. (Image source: Consultancy.asia)

However, to operate, these digital banks must comply with the outline released by BNM in March. Dubbed the Exposure Draft on Licensing Framework for Digital Banks, it states that applicants must adhere to the Financial Services Act 2013 or Islamic Financial Services Act 2013, and during their “foundational phase” or commencement of operations period, are required to maintain a minimum paid-up capital of RM100 million and will be subject to an aggregate deposit cap of RM2 billion. 

Most importantly, BNM requires all digital banks to focus on financial inclusion and the underserved and unserved market segments, which include the B40 and the Micro, Small and Medium Enterprises (MSME) in efforts to boost sustainable economic growth. (We dive deeper into the BNM digital banking framework below)

Though the COVID-19 pandemic has impacted digital banking by delaying the license awarding process, experts still expect digital banks to be on-track for its introduction by 2021. 

The need for social distancing and safe banking in the wake of the pandemic has magnified the value and necessity for digital banking. 

On top of that, an increasing appetite for digital banks – a PwC report states that 74% of Malaysians are interested in becoming a customer of a virtual bank – shows that Malaysians are ready to adopt such technology. 

This digital effort is also in line with the government’s Shared Prosperity Vision 2030 (SPV2030) agenda, which aims to reduce barriers to access digital technology and make the digitization process inclusive for all.

All in all, Malaysia is on course for, what has been widely cited as, one of the biggest disruptions to the financial services market in decades.

But what does this revolution mean for everyday consumers and businesses? CompareHero.my spoke to a few experts to get their insights. 

But first: digital banks vs incumbent banks – what’s the difference?

A significant difference between the traditional banks and digital banks is the enhanced customer experience, according to sources we spoke to. (Image source: Capgemini via The Financial Brand)

Also known as virtual banks, digital banks are often misunderstood for online or mobile banking platforms – a misconception because both involve basic banking transactions like account management, funds transfer and payment of bills on the bank’s website or via mobile.

But digital banks are more sophisticated and elaborate: they involve leveraging technology in every banking activity, process and stage when it comes to delivering banking products and services, with the goal of making the customer’s experience more seamless, effective and efficient – and within this process, eliminate the need to be at a physical location. 

“Their business model targets very specific segments of the market and customers, unlike traditional banks who serve A-Z when it comes to customer needs. Digital banks tend to pick a very specific micro segment. For example, you might have new digital banks that  target gig workers or SMEs,” said Shankar Kanabiran, a partner in the Financial Services Consulting practice of Ernst & Young Advisory Services Sdn Bhd (“EY”) to CompareHero.my.

Digital banks rely heavily on technology and leading practices like big data, machine learning, and a high degree of automation, leveraging cloud, analytics, and artificial intelligence (AI) to enhance the customer’s experience beyond just the typical banking transactions of credit and debt. “They are highly dependent on technology and work with the ecosystem,” Kanabiran said. 

But the most significant difference between digital banks and traditional banks is the customers’ journey – a digital bank journey starts online and stays strictly online (or via a smartphone app), discarding any need to visit a physical location. “They don’t try to compete head on with the traditional banks by serving end-to-end. They do not have branches to support their operations and most customarily use mobile apps to reach out to their segments. What differentiates them are world-class customer and user experiences,” Kanabiran added. 

And while traditional banks have a larger number of employees and often operate through a network of branches, digital banks are the antithesis of this concept – operating via straight through processing – an automated electronic payment process used to speed up financial transactions from initiation to final settlement, and free of human and manual intervention. “By doing this, they can keep their cost-to-income ratio quite low compared to the traditional banks and these savings are passed on to their customers via higher interest rates or lower lending rates,” Kanabiran  said. 

When it comes to dealing with queries or concerns, Kanabiran said digital banks are able to serve customers through the app or via robo servicing compared to traditional banks that will usually require customers to get in touch with the call centre or visit their branches. 

Finally, from a talent or workforce perspective, Kanabiran said digital banks consist of tech-savvy individuals, or people from different, multidisciplinary backgrounds who work as a team to drive the value proposition. 

Now that we’ve understood how digital banks operate, we can better understand the benefits that they have to offer. 

Digital banks deepen financial inclusion in Malaysia 

A report by the World Bank reveals that Malaysia has one of the highest financial inclusion rates in the world, as 92% of Malaysian adults have a deposit account, meaning they can save, withdraw money, access automated teller machines (ATMs), and carry out payments through electronic means nationwide.

Despite this massive achievement, Malaysia still faces challenges when it comes to financial inclusion such as reaching out to the remaining unserved population – a large part of which comprise foreign workers and their families, some of whom are undocumented workers, according to the World Bank report. Other reported challenges are to ensure that the people with access to financial services actually make active use of their accounts, and that employers make use of direct deposits instead of cash when paying salaries. 

One way to promote financial inclusion, as identified by BNM, is through the establishment of digital banks. In its framework, BNM has outlined that serving the underserved and unserved in retail and SME are among the key requirements for organizations interested in establishing digital banks. 

One way digital banks obtain credit information on SMEs is via transaction data and business volume information available on e-commerce platforms. (Image source: Deloitte) 

Micro-SMEs and SMEs, who typically experience high servicing costs and low revenue potential, face extreme challenges in obtaining traditional credit facilities due to their limited track record and low credit scores which typically result in high loan rejection rates. It also doesn’t help that the processing and approval process of credit facilities is lengthy and intricate. 

A digital bank, through its data analytics and machine learning algorithms, according to a PwC Malaysia report, could potentially provide a solution for this issue via innovative solutions to accurately assist in credit assessment and lending decisions, and lower servicing costs to micro-SMEs. 

Digital banks could also offer better accessibility to rural areas. “Though the population in the urban areas has increased significantly in Malaysia compared to rural areas, the accessibility of the rural population to banking products is still not sufficient,” Kanabiran said. 

Gig workers are another segment of the economy that may benefit from digital banking because of the unique operating model that it offers. “The gig economy is another segment (that is underserved) – this is where a lot of people are taking up gig work like driving for Grab,  freelancing etc., and they do not have access to financial products such as lending because they don’t have salary slips and banks usually require salary slips as part of credit assessment. Digital banks are able to serve this group because their operating models are different,” he added.

Digital banks provide an additional platform for consumers and SMEs who want to transform digitally 

During these challenging times, SMEs and consumers are turning to digital alternatives out of necessity, and digital banks offer a substitute that is safer, more effective and convenient. 

The new normal of banking is steering away from branch-driven, product-centric organizations with legacy technologies and cultures to consumer-centric organizations with more personalized solutions that can be delivered seamlessly and effectively. 

Firms that can deliver fully digital, platform-based banking will help ramp up significantly lower acquisition costs, improve efficiency ratio and result in much lower costs of distribution, according to the World Banking Report 2020 from Capgemini and Efma. 

On top of that, unlike traditional banks, digital banks may continue to operate seamlessly with minimal disruptions during a crisis situation, because of their ability to design their own, unique process flows and are not necessarily dependent on being on-site to serve their customers, according to a PwC Malaysia report. 

Digital banks leverage on rich data insights to deliver more personalized digital experiences for consumers – particularly relevant in today’s COVID-19 era, where all consumers want customized solutions for their own individual crisis-related needs. 

For example, a PwC Malaysia report states, by understanding a consumer’s spending patterns, digital banks – through the use of analytics tools and platforms – will be able to direct consumers towards promotions on their partners’ platforms. 

The changing socio-economic landscape in today’s COVID-19 world is further supported by a statement from KPMG in Malaysia’s Head of Financial Services, Adrian Lee, who said the COVID-19 had altered customers’ money management and spending patterns as well as the way businesses are run, with mode of payments and channels of financial management also changing – many of which becoming digital. 

“Digital banking presents a value proposition poised to help companies and individuals get back into the economic saddle, and financial services providers that design [their] products around customer needs will stand out the most,” he said. 

Digital banks offer different customer experience 

From the consumer end, Paul Francis, Financial Services Strategy Director of PwC Malaysia told CompareHero.my that digital banks would utilize data in new, unexplored ways compared to incumbent banks when serving the unfulfilled segments of society. 

“From a consumer’s perspective, there’s a lot of unmet demand today, and it is partly because, as banks, it is hard to give you the information to be able to qualify for credit, for example,” he said. “Or it is hard to find products that are priced appropriately. So if you were going to go down the digital banks pathway, they use data in a very different way than virtual banks when assessing risk.” 

Through the use of data analytics and enhanced processing of data, digital banks can potentially understand customer needs better. “For example, one firm I know of in the United States of America that is talking to people here in Malaysia about being a virtual bank, offers payday advances. So if you have an account with them, they have insights such as knowing that you are running out of money for the last five days of the week,” he said. 

Using data and analytics, digital banks, he said can generate small amounts of money, with very low risk, all while helping save people from money lenders that take very high margins. “A good reason they can do this is that they have a very good understanding of every individual customer’s transaction history,” Francis added. 

Legacy banks, unlike digital banks, Francis said have only historically collected data to run their products transaction systems and for regulatory reporting purposes – but have underutilized a lot of information about consumers that can be used to predict behaviors. Virtual banks on the other hand, he said, will take advantage of such data to drive decisions and position it as a key competitor advantage. 
It only takes 22 seconds before payment can be made on Monzo, a challenger bank (another name for digital bank), according to a comprehensive study by app experts Built for Mars. (Image source: Sifted)

Some of the potential promises of digital banks include slicker app interfaces and speedier features, both offerings targeted at the retail market. A comprehensive study by app experts Built for Mars, as reported by Sifted, validates the view that digital banks will outdo incumbent banks when it comes to optimizing banking performance. 

Built for Mars’s research, which looks at how long it takes to send money domestically on each account, shows that the UK digital banks are all faster than average when compared to other incumbent banks – Monzo, Starling and Revolut all top the charts, according to a news report by Sifted.

Customer experience will be at the forefront of digital banks so it is imperative that digital banks ensure that when designing business processes, sufficient customer data protection plans are in place. Digital banks, Francis said, should also focus on customer value proposition (CVP) when designing their business plan, strategy and target operating model.

Key requirements in the BNM digital banking framework

Despite being “digital,” these banks still need to comply with BNM regulations, here are several key requirements in the BNM digital banking framework that we feel are important to take note off:

• For starters, digital bank applicants will need to demonstrate their ability and capacity to operate sustainably, including showing a defined asset threshold not exceeding RM2 billion (approx. US$468 million) in its initial three to five years of operations.
  
  
• Applicants will need capital funds of minimum RM100 million in the foundational phase and RM300 million thereafter to safeguard the integrity and stability of Malaysia’s financial system.
  
  
• Demonstrate robust risk management and compliance capabilities.
  
  
• Be able to apply transformative technology in the development and delivery of financial services, such as scalable and agile tech stack built on microservices architecture.
  
  
• Have access to deep and robust customer analytics that may be utilized to improve and expand access to and responsible usage of financial services.
  
  
• Able to continuously serve as a source of financial strength to the proposed licensed digital bank.
  
  
• Applicants must comply with the Financial Services Act (FSA) and Islamic Financial Services Act (IFSA) regulations.
  
  
• With respect to licensed Islamic digital banks, the requisite Shariah expertise to effectively carry on Islamic digital banking business.
  
  
• Digital banks may participate in the Shared ATM Network and any other cash-out services offered by PayNet.
  
  
• Digital banks may be permitted to offer financial services through agents, subject to the Bank’s approval.
  
  
• Digital banks are not allowed to establish any physical branches.

The major players – where they stand 

Experts are expecting BNM to see a large number of applicants, among banking and non-banking institutions and a variety of sectors, due to the lower entry requirements in minimum capital and significant market opportunities locally and in the region. 

Successful candidates would be institutions that are able to demonstrate financial inclusion by showing how their products and services will help the underserved and unserved segments rebuild themselves financially. 

Though no licenses have been awarded as of yet, there are news circulating on the different types of platforms that may opt to run a digital bank. 

A few months ago, Fintechnews.my reported that Axiata Group was in talks with Bank Negara Malaysia to obtain a digital banking licence. The telco group is also engaging with up to 11 parties including banking institutions, to make the bid for the licence.

Boost, Grab, TNG Digital, Razer Pay, Axiata Group, and US-founded financial start-up MoneyLion Inc, are other players that, as reported by The Star, interested in securing a potential digital banking licence.

On the banking end, CIMB Group, Affin Bank, AMMB Holdings and Standard Chartered Bank Malaysia, Hong Leong Bank, are among the banks that have signalled interest in a digital banking licence. 

Final thoughts – digital banks will be huge, and you should be on the lookout for it 

Though digital banks in Malaysia will focus on financial inclusion and the underserved, such as the B40, micro-SME and SME market segments, these banks are also offering retailers with a vast new and improved customer experience. 

Each digital bank will offer a very unique proposition of their business, and it is up to us as consumers to be able to tell which product offering suits our situations best. 

We hope this piece on digital banking was educational and informative! Good luck researching.