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PETALING JAYA: The digital bank licence winners in Malaysia are likely to assume niche market roles rather than disrupt the banking sector in the medium term, according to Fitch Ratings.

Bank Negara Malaysia (BNM) last Friday announced the five consortiums that won digital bank licences. They are Boost Holdings Bhd-RHB Bank Bhd, GXS Bank Pte Ltd-Kuok Brothers Sdn Bhd, Sea Ltd-YTL Digital Capital Sdn Bhd, Aeon Financial Service Co Ltd-Aeon Credit Service (M) Bhd-MoneyLion Inc and KAF Investment Bank Sdn Bhd.

Fitch believes each consortium is well-resourced with the potential to become a viable digital bank in the long run. Qualities include broad consumer brand recognition, strong credibility of constituent shareholders, deep pockets to fund necessary investments and the likely availability of management know-how. Execution risks are considerable, but the ingredients to make a foray into the sector are present.

“We believe there is a long-term future for digital banks in Malaysia, particularly in tackling certain niches. These tend to revolve around under-served clientele, such as lower-income consumers and micro and small enterprises that lack the collateral or cash flow required by banks to qualify for credit. Digital banks are likely to be active in less capital intensive areas, such as payments and remittances, distribution of third-party investment and insurance products as well as selective lending where there are synergies with their parent eco-systems. For example, there could be a natural fit in payday loans to gig workers or supply-chain financing for e-commerce merchants,“ it said in a commentary.

However, it noted that digital banks are not likely to become major competitors to traditional banks within the next five years, because of regulatory limits placed on their operations. BNM’s licensing framework caps the digital banks’ assets at RM3 billion (US$688 million) during the foundational phase, which they cannot exit until at least mid-2026, and potentially as late as mid-2029. This means aggregate digital bank balance sheets will be less than 1% of the system in the medium-term under even the most bullish assumptions.

“There are other structural market hurdles for digital banks to overcome before they are likely to become profitable. The first is attaining scale. BNM states that 8% of the population is unbanked and the vast majority of these people have little or no income, which suggests they are not likely to become bankable simply because of renewed competition or better digital services.

“Competitive pricing is also a barrier. Malaysia is a well-regulated jurisdiction, with supervisory guidelines and prevailing practices that espouse responsible financing. The availability of unsecured financing at comparably low rates of 15%-18% is likely to set low benchmarks on what new entrants can realistically charge, which may not be adequate to compensate for the higher risk of lending to lower credit-quality customers.

“Lastly, major local banks have formidable market share and are, in our view, capable of quickly responding to and competing with digital banks. The large banks’ incumbency advantage is unlikely to be eroded within the medium term, even if competition intensifies at the margin in areas that the digital banks choose to compete in,“ explained Fitch.

It added that the digital banks are being set up amid an economic recovery that gives the new banks a decent prospect at growing their balance sheets in the initial years. However, economies of scale will be elusive amid the size cap and competition is likely to be acute. Near-term asset-quality risks are high, as the banking sector is emerging from a period of extensive debt relief. Digital banks that adopt loose underwriting standards to grow market share may encounter distressed borrowers clutching at the nearest lifeline, leading to adverse credit selection.

“The path to financial viability for digital banks remains open, but we believe it will be a long and trying ascent,“ said Fitch.

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