The Rise of the Neo Banks and the Implications for Wealth Management in Asia
Dec 20, 2019
Hong Kong has issued eight new ‘virtual banking’ licenses. Will the experiment work, both for the customers and for the start-ups and their shareholders? What does this mean for the traditional banks and their customer base? What are the implications for the wealth management industry? Hubbis assembled a panel offering immense expertise to provide delegates at the Digital Wealth Asia Forum their insights on positioning themselves for what is the seemingly inevitable rise of the robo-banks.
The Key Takeaways
The customer experience is central to Neo banks, but beware the regulatory small print
As the digital banks, otherwise known as ‘virtual’ or ‘neo’ banks, prepare to launch in Hong Kong, experts warn them that there are many potential regulatory mines out there they will need to address, which might somewhat undermine the customer experience, which is so central to the proposition. Being ‘virtual’ players, dispute resolution might be problematic.
Different regulators for different aspects
The virtual banks will start on a limited basis, but later will likely deal in banking products, securities products, insurance, in short, the whole banking ecosystem, but they will need to address regulatory issues with the three different Hong Kong regulators, another challenge that might water down the customer experience.
Accessibility is laudable, but beware of limitations
Virtual banks offer digital service, allowing them to be more accessible to customers, but the eight new licensees approved in Hong Kong can only offer domestic business, so they must be careful who they onboard and how.
Starting small, the neo banks will very likely gain traction over time
The panel indicated the neo banks will likely start their operations on a very limited basis and build up their product offerings step by step. Meanwhile, some of the incumbent banks in Hong Kong already have digital offerings that are more compelling than the virtual banks will be offering initially.
Brand recognition will hinder some of the neo banks and help others
Hong Kong residents are brand conscious. The virtual banks that have partnerships with or ownership by brand-name companies will initially have greater trust.
The potential rewards for the disruptors are significant
A panel member noted that the top four banks in Hong Kong own between 70% to 80% of the market in terms of mortgages and loans and credit cards, giving the neo banks a major target to shoot for.
Greater digitalisation and segmentation will follow amongst the traditional banks
Examples from Australia and other countries highlight the need for greater digitalisation by the mainstream banks, so Hong Kong is indeed likely to follow that path. Moreover, both rising costs and competition from the neo banks will mean that these banks will likely segment further, so that, for example, they can digitally offer more products to more customers, while reserving more face-to-face coverage for their wealthier clients.
The virtual banks will need scale to become profitable
The great challenge for the virtual banks will be customer acquisition, which might be both slow and costly. Once some of these neo banks can reach critical mass and achieve scale in their breadth of offerings, only then can they realistically think about making profits.
The mass affluent market offers considerable appeal
The panel noted that there is a significant amount of money swilling around in Hong Kong banks doing very little. If the neo banks can reach those mass affluent customers and convert that relatively dormant money to more active investments, they will have opened up a rich seam.
Whatever the short-term outlook, the longer-term potential is certainly evident
For those neo banks that can survive and then achieve scale, the outlook a decade ahead appears very positive as more of the younger, digital natives will control the wealth in Asia, and as more and more customers expect digital interface with their financial institutions, as a matter of course. The winners will also have found new avenues for profitable activity, such as under-served sections of the SME market.
Disruption is inevitable
The final comment was that further disruption is inevitable. This could come from tech giants entering the financial services sector, or from incumbent banks partnering with BigTech, or being acquired by them. Whatever happens, the best of the virtual banks would have within five to 10 years grown into far more robust competition for the incumbent banks, including in the arena of wealth management.
A panellist opened the discussion by explaining that the customer experience and customer journey is central to a virtual bank’s offering. “An issue is very often the regulatory questions arising,” they explained, “as we often feel they need disclaimers, pop-up boxes and so forth for consents, for clarification, and so forth. The concern is that the more innovative and simpler the customer journey is in the design process, the more regulatory and legal issues could arise. When the design team design the customer journey, they therefore need to involve the legal and compliance team as early as possible.”
“Yes,” came another voice, “it is a misconception if people think virtual banks are not subject to the same level of regulatory scrutiny as traditional banks because they most certainly are. They are subject to all the obligations to treat the customers fairly, exactly the same as other banks. But the virtual banks don’t have physical channels that are able to resolve problems, and that can be difficult via digital alone.”
Another expert commented that virtual banks offer digital service, meaning they are in theory more accessible to customers, including customers who are potentially outside of Hong Kong, for example. But in Hong Kong, they are only permitted to provide services to customers in Hong Kong, so they need data on them for onboarding, which means another regulatory issue to overcome, to ensure that only the permitted customers are enabled.
Another issue is that virtual banks will deal in banking products, securities products, insurance, the whole ecosystem, but this means they also have to work with three different regulators to embed regulatory compliance, yet without spoiling the customer experience.
Start small, build fast
“The virtual banks are going to be quite restrictive in their initial offerings and mostly will only have deposits, lending, savings, and for the corporate class it is not going to be a virtual banking experience either, it is going to require visiting their branches, not their virtual branch, but their actual physical location,” and other guest reported. “So, the offerings for virtual banks probably at least for the first year won’t have a lot of products tied to them like insurance or securities or other. Of course, they may in future, for example, one of them is controlled by an insurance company. And as far as I understand, they are not going to be issuing debit cards or credit cards either, at least in the first phase of their offering and you probably won’t be able to use any transactional activities overseas.”
He added that dealing with fraud and other problems will be challenging as they will have low staff numbers. “They are going to have to pass a lot of HKMA tests and stress tests around that, some of them are going to have soft launches before that, most likely limited at first to friends and family of employees and related customers that are maybe in their ecosystem from a vendor perspective. Looking to the future, the idea is clearly that they are going to bring customers into their ecosystems and tie them in as much as possible.”
Mainstream banks look solid…for now
A guest remarked that some of the banks in Hong Kong already have digital offerings that are more compelling than the virtual banks will be offering initially.
People in Hong Kong tend to like the big names, another panellist added, so those virtual banks with partnerships with brand-name companies will initially have greater trust. “But here in Hong Kong the top four banks own between 70% to 80% of the market in terms of mortgages and loans and credit cards, so theoretically the market is ripe for disruption.,” he observed, “so although it might be slow at the start, the virtual banking market will soon take off.”
Another expert remarked that Hong Kong demonstrates attributes of a typical post-colonisation economy where oligopolies dominate the entire economy. “That will change, and customer protection will improve, especially for banking customers,” he observed.
Shaking things up
A guest commented on developments in other markets such as the UK and Australia, noting that there has been increasing transparency, that the regulators are now more aligned in their views on how to tackle many of the issues, and that this type of protocol will come to Hong Kong before too long.
Looking at Australia, this same expert noted that the big four banks which dominate perhaps 80% of the banking landscape and the big six wealth managers, four of which are also the major banking groups, are now diverging in terms of their strategies. “One of those major banks is moving out of wealth management now, another has decided to only focus on the upper end of retail client base, so customers with more than half a million Australian dollars get face to face service, and another bank seems to be just going around circles.”
The one commonality, he remarked, is that everybody acknowledges they need more digital capabilities across the entire value chain, to either serve the customers you want to serve face to face or to access a broader range of customers and redefine their products, to deliver to a broader range of customers in a more effective, cost-efficient way. “The challenge for all the organisations we are talking to locally and globally is where on earth to start,” he stated.
Another expert noted that the cost of compliance and the cost of running the business has actually increased about seven-fold in the last 10 years in Australia. “The cost of providing advice is gruesome these days,” he warned, “somewhere in the region of AUD10,000 for the average customer, and of course customers are not going to pay up for that.”
The economic realities
The discussion moved to the economic realities for the challenger banks, with a guest commenting that much of their proposition relates to pricing, on deposits, savings, banking fees, transfers, FX, and so forth, meaning it will take considerable time to become profitable because to do so, achieving volume is essential. “The market here is really not big enough for eight new entrants,” he cautioned, “unless the market expands for example to the Greater Bay area and further. And cross-selling only makes sense once the customer base is large enough, then you can offer a wider variety of solutions.2
Nevertheless, another guest observed that there are players in the region who are managing to turn their digital propositions into profit. “Some new entrants in China and Korea, for example, have quickly become a profit-making machine,” he noted, “and what they have in common is being able to leverage or being able to acquire quite rapidly a large set of customers through a variety of means, including messaging apps and so forth.”
Mass affluent sector beckons
He observed that wealth offerings will be the next steps, as there is money to be made in the mass affluent space and higher categories. “There is a huge amount of money in Hong Kong, for example, sitting around in all those retail accounts, this can be converted to wealth or insurance or other products that can make more money for the new banks.”
A panellist shifted the discussion to imagining the future in five to 10 years for these neo banks. While there will not necessarily be a great impact in the near term, the technology and architecture set for the future will be very easy to then adapt and to expand. Another guest agreed but added that the regulators are more likely to hinder progress for these new entrants, as they will want to ensure that they are compliant, well-controlled and well-supervised and therefore that they do not increase the risk of financial instability, or risk customer wealth/assets.
Too visible to fail
A panel member noted, for example, that there were 33 applications in Hong Kong, “The HKMA has been very careful about the entrants that they have let through,” he explained. “You will notice that many of them are majority-owned by existing banks, so it will be disastrous for the HKMA to have big failures or even small failures when these banks launch. The HKMA cannot be seen to have permitted unsafe institutions to deal with the general population, especially as their role is also promoting financial inclusion. These neo banks will be tightly supervised and tested throughout.”
Another guest noted that the new entrants, for example, in Australia, will also find new avenues for profitability. He pointed to the digital players promoting SME loans that might have been bypassed by the traditional banks. “For SME lending,” he reported, “we have got a number of large banks that have now partnered up with the virtual banks, with alternative lenders, to offer more competitive cash-flow based lending products to their small business market without cannibalising those banks’ core lending products. There is actually a huge opportunity out there.”
A brave new world
The panellists were asked to look ahead five to 10 years. “There is certainly much more disruption coming,” said one expert. “This could be from the tech giants, but also it could very well be that we would see a lot more partnerships between tech and financial services firms. There you already a lot of this collaboration going on in certain markets, playing to each of their relative strengths.”
But a word of warning came from another expert who noted that the zero face-to-face protocol does open the door to fraud problems, concerns on customer screening and transaction monitoring. “And the virtual banks do not have the historical information to calibrate the systems accurately in the early phase,” he added.
Another expert added that one direct result will be a reduction in physical branches, especially in Hong Kong, where there are so many due to past regulations.
And the final comment was that within a decade, the better virtual banks would have grown into far more robust competition for the incumbent banks, especially in relation to wealth management.
“The lines between the virtual bank and traditional bank will become blurred,” they predicted, “so, for example, the virtual banks do want to leverage existing infrastructure like ATMs, for example, to deliver their service, while the traditional banks want to expand digitally, through more APIs and so forth.”
The result, if all goes well, will be greater customer centricity and a wider range of products and services delivered more optimally and more cost-effectively.