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A Wave of Virtual Banks in Asia: How Should Incumbents Respond?

Aamod Gokhale

Managing Principal, Business Consulting, EPAM
  • Financial Services

Regulators in Asia are ushering in a brave new chapter in banking as the Monetary Authority of Singapore just announced that five new virtual banking licenses will be issued. This news comes on the heels of similar licenses being awarded by other countries’ regulatory bodies in South Korea, China, Hong Kong and Australia. Meanwhile, Taiwan, Malaysia, Japan, India, Vietnam, Indonesia, Philippines and Thailand continue to allow existing traditional banks to launch virtual banks and are closely watching the development of banking licenses elsewhere.

Clearly, this is just the beginning of a wave of new virtual banks in Asia, and it’s safe to say that the banking industry will look radically different in the near future as new banking models will bring a lot of excitement, as well as product and service innovations. Consumers are sure to experience the benefits of virtual banking, but what does it mean for the incumbent banks who have yet to or are struggling to virtualize their service offering?

A Different Breed of Bank

These developments are not unexpected. Digital financial services in areas ranging from payments to remittances to robo-advisory are growing, and even a few regional banks have launched their own virtual banks in some countries. But the new virtual-only banks are a completely different breed. For one thing, most of them have been launched by entirely new, non-financial services players who are technology and AI firms first, banks second. With a vision to change the way financial products and services are delivered, they lead the market with innovations that appeal to consumers.

Even this early on, it’s clear that virtual banks are growing several times faster and cornering a substantial chunk of new accounts, deposits and loans. For instance, in the 20 months since Kakao Bank launched its services in South Korea, it has attracted more than 10 million customers, making it already comparable to a top 10 bank in Korea – and its customer acquisition costs are a fraction of what it costs a traditional bank. In China, Alibaba’s MYbank has distributed a staggering $290 billion in small loans to 16 million small businesses in just three years, and WeBank achieved about $21.5 billion in deposits in 2018. Both banks are already quite profitable.

Analyzing the Impact of Virtual Banks

Virtual banks scale rapidly because they are asset light, born digital and able to connect with consumers in very different ways. The parent firm of Kakao Bank owns an ecosystem of businesses including a messaging app, a ride hailing app, a transportation platform, a payments app and so on. The ride hailing app – Kakao T – held a 97% market share in 2018 and provides an enviable platform to onboard customers to its bank. All these products deliver unparalleled customer insights through extensive use of AI across the ecosystem. This is a common strength used very effectively for competitive advantage by virtual banks globally.

Furthermore, with their low-cost operations, virtual banks can charge substantially lower fees and commissions, forcing other banks to do the same and hurting their profitability. By March 2019, Kakao Bank’s loans-to-deposits ratio was only 65% compared to 96%-98% for other banks, and yet that was enough for it to record a quarterly profit. It is hard for traditional banks to match such cost efficiencies, yet they have no choice but to find ways to close the gap.

Fighting Back: Seven Strategic Imperatives for Banks in Asia

Speed and strategy are vital if traditional banks want to protect their market share and grow profitably. Past performance is not going to matter as virtual banks succeed in radically changing the landscape. We have seven recommendations for traditional banks:

  1. Embrace Digital/Virtual Banking Aggressively
    Many large banks have already set the ball rolling, with some starting their transformation journeys in the previous decade with a focus on customer experience. But those banks that have not yet shifted their focus need to move quickly. Just launching mobile banking with a new brand name is not enough. To succeed in virtual banking, banks need a mindset to act more like a tech firm, less like a bank. It is a cultural transformation that banks need to accept and adopt.
  2. Obsess about the Customer Experience
    Banks must become obsessive about the customer experience in every interaction. Not just millennials, but anyone who banks actively is drawn to a great experience. The good news is that eKYC and KYC utilities will soon make it easy for banks to onboard customers digitally in many countries, but that’s just one of the ways banks can improve the customer experience.
  3. Differentiate
    In the past, it didn’t matter that banks were so similar in their service offerings since they were only accessible on a local or regional level, but the internet makes it possible to bank with anyone, anywhere. As the market gets crowded, banks must create a sharp identity and articulate a vision and strategy to differentiate and stand out. That differentiation needs to also reflect in the customer experience and services – including at branches, ATMs and in-person meetings.
  4. Reimagine
    Only launch products if they offer a new experience or proposition. Launching the same old products over mobile will not work. Even if something is not new or different from what was previously offered, it has to be delivered in a novel way and must lead to rapid cross-selling.
  5. Fast Launch or Fast Follow
    This is where technology really matters – specifically having a modern, open and flexible enterprise architecture, data architecture and AI/data science capability supported by agile delivery at scale. Innovative ideas must be taken to market quickly, and banks must be able to quickly follow a competitor’s idea or integrate innovations from fintech ecosystem partners. Many old banks claim to have transformed their IT operating models and architectures, but reality is somewhat different.
  6. Reduce Costs
    Banks will have to reduce the costs of operations and customer service dramatically to match virtual banks. Focusing on short term ROI resulting in piecemeal automation and transformation may backfire in the long term. Finding innovative ways to do this, including new operating models, will help to substantially reduce the cost of operating physical infrastructure, while potentially delivering an unmatched experience of person-to-person interactions for offline financial services.
  7. Grow Digital Maturity & Intelligence
    Large banks that have succeeded in the above points still need to focus on not only achieving higher digital maturity, but also investing to drive continuous innovation and digital intelligence across their organization. In doing so, they’ll have an in-house workforce capable of rolling with the punches and adapting to further phases of digital transformation.
Conclusion & Next Steps

The next decade will bring a surge in new entrants and innovations, but also a period of turbulence and consolidation in banking in Asia. A leading consulting firm predicts that unless the traditional banks in Asia transform and embrace virtual banking, their financial performance may plummet drastically, with ROE falling to 6.4% by 2023  – nearly half of what it was in 2010. Similarly, S&P Global has warned of the potential impact on credit ratings of traditional banks in Asia due to the impact of virtual banks.

Much to the advantage of incumbent banks, virtual banks still need to build trust and scale risk management. To stay ahead or at least keep up, incumbent banks need to focus on their competitive position beyond 2023 – a point when financial metrics should look healthy again assuming they regain their competitive advantage even as virtual banking becomes mainstream.

Banks that make the right investments prioritizing business transformation over short-term profitability will emerge much more efficient, nimble and innovative. Traditional banks must aim to match or exceed the customer experience and innovations with their own virtual and personal banking to prove the doomsday projections wrong.

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