Virtual banks may hurt small local lenders, Fitch says


SMALLER banks in Malaysia may be adversely affected by the central bank’s plan to issue up to five digital bank licences this year, Fitch Ratings Inc said.

According to Fitch, the proposal to grant up to five digital bank licences will likely intensify competition in the banking industry which is already experiencing margin compression, making smaller banks potentially more vulnerable.

“Keener competition could also spur a build-up of debt within the highly leveraged lower-income borrowers, if not monitored, with the new digital players eyeing the underserved and unserved retail market, though we believe such risk is likely to be contained for now in light of regulatory curbs and oversights,” it said in a statement yesterday.

Last December, Bank Negara Malaysia (BNM) announced its plans to issue up to five licences to new online banks offering either conventional or Islamic banking under a proposed licensing framework set to be finalised in the first half of this year.

The Exposure Draft on Licensing Framework for Digital Banks outlines the proposed framework for the licensing of Internet-based banking products and services that will offer banking products and services to address market gaps in the underserved and unserved segments.

The banks would also need to demonstrate their viability in the first three to five years of operations, with an asset threshold of not more than RM2 billion during the period.

Additionally, it will be required to maintain minimum capital funds unimpaired by losses of RM100 million during the foundational phase, and RM300 million thereafter.

The agency highlighted that while competition is already tough, with more than 30 commercial and Islamic banks vying for a larger piece of the pie, this has put further pressure on margins at a time when growth prospects remain muted.

“Competitive pressure could heighten as new entrants try to build their deposit pools. This should pose a greater risk to the smaller Malaysian banks, given their modest franchises,” it said.

The rating agency believes that new entrants are likely to target the underserved retail and small and medium enterprise segments which typically have a higher risk profile and lower income.

“The new digital players should have a faster speed-to-market to attract such borrowers than traditional players, being potentially equipped with advanced customer analytics and digital capabilities.

“This may once again put the spotlight on household leverage, which remains high in Malaysia (82% of GDP at end-June 2019). Debt-to-income ratios of the vulnerable households (those earning less than RM3,000 or US$730 per month) are high and have been rising in recent years (end-June 2019: 8.9 times, 2015: 7.7 times),” it said.

Additionally, these borrowers, according to Fitch, accounted for about 19% of total household debt as of end-June 2019, and the household sector comprised roughly 58% of bank lending.

It noted that the proposed stipulated end-point capital fund requirement of RM300 million (US$73 million) for the licensed digital banks is much lower than Singapore’s S$1.5 billion (RM4.52 billion), implying a lower barrier to entry.

However, Fitch believes the asset size cap of RM2 billion per digital bank within five years should help limit any build-up risk in the system.

“Moreover, the requirement for new operators to demonstrate a path to profitability and business sustainability should also deter unsuitable entrants or unsustainable business models, reducing the risk of irrational pricing and value-destructive competition.

The rating agency also sees the likelihood of existing banks cooperating with financial technologies to secure a virtual bank licence, where the bank provides balance sheet, capital and risk management, with the latter offering technological know-how.

“These tie-ups could eventually enhance the incumbents’ franchises through cross-selling and by leveraging each partner’s digital platforms and capabilities.

“New dynamism could also propel further innovation within the industry, such as new risk-management practices,” it said.

A study by the Bank of International Settlements in April 2019 highlights the alternative credit-scoring technique — based on Big Data and “machine learning” — employed by digital lenders in Argentina, which was able to predict loss rates of small businesses better than credit bureau ratings.

“We believe that some new digital players in Malaysia may also adopt similar practices.

“Nevertheless, caution is warranted when financial institutions become too reliant on these risk-management techniques as they have not been tested through economic cycles,” Fitch added.