Hong Kong’s banking authority had lofty goals of boosting fintech innovation and social inclusivity when it gave out the first virtual banking licenses in the first half of 2019, but for the eight lenders that have since started operations, immediate challenges are plenty and mounting.
Their priority, mirroring the playbook of growth-oriented companies, is uniform – gain as much market share as quickly as possible without worrying too much about costs and strategy.
Just how many will succeed is open to debate. Not only are these banks competing with traditional players but also with each other in a crowded market. How they differentiate themselves will be crucial to ensure customer loyalty after the lure of promotional gimmicks fades, say analysts. Beyond gaining customers and accounts, they will have to deal with credit risk management practices and ensure data protection, areas that trip up even established players with far more experience.
Hong Kong has nearly 160 traditional banks for its 7.5 million population although HSBC, Bank of China and Standard Chartered have long dominated the scene. The virtual banks’ backers include Chinese technology heavyweights, which has raised expectations that the initiative could speed Hong Kong’s fintech development and narrow the gap with China and Singapore.
ZA Bank, the first to start operations in March, is co-owned by mainland online insurer ZhongAn Online P&C Insurance, and property investor Sinolink Group. Ant Bank is an affiliate of ecommerce giant Alibaba Group Holding while Fusion Bank is backed by social media giant Tencent Holdings and Industrial & Commercial Bank of China, the world’s largest lender by assets. Ant was launched in September and Fusion, in October. livi Bank, which began operations in August, is supported by Bank of China, fintech company JD Digits and the Jardine Matheson Group conglomerate.
'New Era'
In his speech at the Hong Kong FinTech Week in November, Eddie Yue, chief executive of the Hong Kong Monetary Authority, described the virtual banking initiative as beginning “a new era of smart banking.” Hong Kong has one of the highest numbers of virtual banks in Asia, Yue said, adding that while they may have different fintech strategies, the diversity is crucial to shape Hong Kong into a global fintech hub.
The digital bank business model includes some obvious assumptions. Since the lenders don’t have to pay for physical branches and staff in the world’s most expensive commercial property market, they can offer better deposit rates, charge lower fees on fewer services, and still make profits.
Social inclusivity would improve without charges such as that for maintaining the minimum balance in accounts. Additionally, virtual lenders can better serve small and medium enterprises as they have access to holistic, real-time data and can use big data models to improve risk assessment and lower approval times and costs for loans. Analysts say SMEs can be a large market as they are more price-sensitive than their larger counterparts, tend to have fewer fund-raising options and face greater hurdles in opening corporate accounts with established banks.
“Virtual banks have a comparative advantage in that once the initial investment is made in areas such as technology and data analytics, there is no need for ongoing investment in physical branches compared with traditional banks,” says David Sun, chief executive of livi.
However, early results show evidence of mounting costs, thanks to marketing campaigns and higher deposit rates to lure customers. Over the first half of 2020, Hong Kong’s virtual banks accumulated a combined loss of HK$850 million ($110 million), with amounts ranging from HK$64 million to HK$185 million across the group.
Marketing Campaigns
ZA Bank is offering a 6.8% interest rate for a three-month deposit while homegrown WeLab is advertising 9.8% on a two-month fixed deposit. The returns are astronomical compared to the 0.25% that HSBC offers on a three-month time deposit but like most promotions, conditions apply. At ZA Bank, deposits are capped. Higher interest rates are only for those who bring in customers through referrals. WeLab capped its promotional offer at HK$10,000 per account.
Most banks are unfazed by the spending, saying it produces results.
“All virtual banking platforms are looking for ways to differentiate themselves. For us, the KPI (key performance indicator) is getting accounts [opened] in less than three minutes and forty-six seconds,” says Deniz Güven, chief executive officer of Standard Chartered-backed Mox Bank.
The bank got 45,000 new customers in the 45 days following its launch in September. WeLab, backed by billionaire Li ka-Shing, opened more than 10,000 accounts in the first 10 days, according to reports.
With little branding, digital lenders are using a similar marketing strategy aimed at tethering customers to the app. “[We] need to incentivize customers to be long-term partners and encourage them to use the livi app daily by offering more products and services that are supported by incentives and rewards,” said livi’s Sun.
Since many promotional periods are about to expire, subsequent customer stickiness will be the litmus test. If depositors who took advantage of promotional campaigns leave for competitors it could create a perpetual round of musical chairs, whereby customers utilize the easy set-up and transfer features to move money across platforms, analysts say.
HSBC - Already a Digital Bank?
High funding costs, driven by the higher interest rates, are a hindrance for growth, said Michael Chang, a banking analyst at CGS-CIMB. He believes that in the near-term, promotional and marketing subsidies are unlikely to abate with competition set to intensify in a weak economy.
Hong Kong’s gross domestic product is expected to have shrunk last year, following a contraction of 1.2% in 2019. The pandemic has eroded the digital advantage by forcing many physical banks to upgrade their platforms while their customers have become more comfortable with online banking.
“We thought long and hard about whether or not to apply for the virtual banking license, but we came to the conclusion that it wouldn’t allow us to do anything that we can’t already do,” says Andrew Eldon, Head of Digital, Wealth and Personal Banking, HSBC Hong Kong. According to Eldon, 95% of the bank’s retail transactions are now done digitally. “So, from that perspective we already think of ourselves as a digital bank,” he says.
The bank has eliminated fees for deposits below HK$5,000. HSBC said they were introduced to offset the higher servicing costs for such accounts.
Analyst Chang says that because global markets are flush with liquidity, incumbent banks may ironically be better positioned with low-cost Current Account Savings Account (CASA) funds, which offer a lower interest rate than term deposits. Such accounts have swelled with the decline in deposit rates and are a cheaper source to fund the bank’s growth than wholesale funding.
Ultimately for virtual banks, it is all about the younger generation looking for a better customer experience rather than a few incremental basis points on the interest rate, says Simon Loong, co-founder and chief executive officer of WeLab.
Credit Risk
In a November commentary, Fitch Ratings said it sees this segment as a prime target as it is under-served by traditional banks which tend to focus more on higher net-worth customers.
When it comes to lending, credit risk management could be a challenge.
Banks traditionally rely on collateral such as property, before issuing loans. However, such a system may exclude younger customers who tend to have fewer assets. Using data analytics and modeled algorithms, virtual banks hope to generate more comprehensive information about borrowers and better price risk.
“Because we are looking at a larger pool of data, we are not only able to flag risk earlier but also offer more timely lending products,” said Mox Bank’s Güven.
However, CGS-CIMB’s Chang says credit risk management could be a sizeable task as it “includes the bank’s ability to price risk, predict credit risk across the cycle and access relevant credit data of customers.”
Analysts say that physical banks have their own advantages as branches have benefited from customer relations that generate the next logical product sale.
From the regulator’s point of view, virtual banks fall under the same banking laws and supervisory requirements as traditional banks. “For all intents and purposes, virtual banks are traditional banks,” says Jolyon Ellwood-Russell, Partner at Simmons & Simmons. “They are exposed to the same risks and practice the same precautions.”
Data Privacy
But they may be better placed than other fintech platforms as they are well capitalized and fall under HKMA guidelines.
Data safeguards could become more important as the platforms evolve. Although customers are seeing lower costs, they are in fact giving up their personal data, heightening risks. Current guidelines are suitable, but “privacy laws could be updated to ensure ethical use of data to meet future conditions” says Michelle Ta, Managing Associate at Simmons & Simmons.
For example, the HKMA has proposed the Commercial Data Interchange, a consent-based common standard that allows data owners to share their digital footprint with banks through data providers, potentially limiting problems.
Such developments may matter for fund managers looking to invest in the next big industry disruptor, says Eric Ritter, a former Asia hedge fund manager and current adjunct professor of economics for Lakeland University in Tokyo.
“For the past decade, investors have traded China’s new economy stocks at valuation premiums,” says Ritter. “Even a virtual bank that breaks even could become a coveted asset.”
