Digital banks step up competition in S-E Asia but near-term rating impact modest, says report

THE proliferation of digital banks in South-east Asia will intensify competition in the banking sector, but the near-term rating impact is likely to be modest for existing rated banks in the region, said Fitch Ratings on Friday (Oct 8).

Tamma Febrian, associate director at Fitch Ratings, said: "Many upcoming digital banks in South-east Asia are likely to be able to rapidly grow their customer base when they enter the market, in light of their extensive ecosystems and ample financial resources, but the path to sustained profitability is less certain."

This is especially so for larger incumbents which have invested heavily in digitalisation in recent years, it said.

Attaining profitability for new entrants is often accompanied by capital-intensive business models, and digital players with deep customer engagement are more likely to secure recurring business and reach sustained profitability, said the report.

But this has proven to be a hurdle for the majority of existing digital banks.

"We believe jurisdictions with large under-served segments and high interest margins, such as Indonesia, the Philippines and Vietnam, offer digital banks in Asean a wider path to profitability, but effective execution remains key," it said.

The report further noted that the competitive landscape is poised to shift with evolving customer preferences and as digitalisation forces banks to continue to innovate. Local regulation will also affect the competitive dynamics posed by digital banks, said the report.

Increased regulatory scrutiny, as seen in China over the past year, for example, could raise compliance hurdles for digital banks and exacerbate execution risks, especially as they become more systemically important.

A levelling of prudential requirements would make it more challenging for digital banks to thrive, and could reduce competition and profitability pressures for incumbents.

The retail and SME segments will likely be the most vulnerable to heightened competition, as many banks will likely adopt an asset-heavy business model, with loans acting as a core recurring revenue generator, stated the report.

That being said, digital banks are likely to first focus on the low-hanging fruit - the under-served segments. Therefore, customers that are on the fringes of incumbent banks' credit-risk acceptance criteria are most prone to being poached by the new entrants.

"We expect funding competition to intensify as digital banks aggressively build their deposit bases, which will leave incumbents with weaker deposit franchises facing more competition," said the report.