The Rise of Digital Banks in Asia Raises Compliance Questions

The entrance of FinTech and BigTech firms into banking is forcing incumbents to adapt, but it should not come at a cost to compliance obligations, writes Claus Christensen at Know Your Customer Ltd.

Singapore is the latest addition to the “Virtual Bank Licences” club. The MAS (Monetary Authority of Singapore) announced on 28 June 2019 that it will soon start accepting applications for up to five new digital bank licences. One of the objectives of this new type of licence is to cater to certain underserved groups of customers, such as SMEs, whereby virtual bank applicants will be asked to prove to the MAS how their offerings will fulfil unmet banking needs.

Singapore’s move followed Hong Kong’s issuance of its first virtual banking licenses. Since March 2018, the HKMA (Hong Kong Monetary Authority) has granted eight such licences. Interestingly, most of the new licensees are backed by established financial services players such as Bank of China Hong Kong, Standard Chartered Bank, and Chinese tech giants Ant Financial and Tencent, with only one being a stand-alone company.

As David Crow and Mercedes Ruehl observe a Financial Times report, some China-based payments and technology organisations are taking the virtual banking route “hoping to use the Hong Kong licences as a springboard to other Asian economies”.

The introduction of digital-only banks in Singapore and Hong Kong has come relatively late if compared not only with other Asian countries such as India, Japan and South Korea, but especially with most of Europe.

Digital banking in Europe

Undoubtedly, new regulations are among the key factors that have contributed to the growth of the digital banking ecosystem in Europe over the past few years. One of the key catalysts has been the Revised Payment Services Directive (aka PSD2), which EU members were given until 18 January 2018 to transpose into local legislation and whose Regulatory Technical Standards will come into force from 14 September 2019.

By advancing the concept of ‘open banking’ across Europe, PSD2 is likely to create an environment where banking as we know it may change drastically. According to a PwC study, two-thirds of European banks intend to use PSD2 to change their strategy, with the majority of European banking executives saying the revised directive will impact all of their core banking operations.

As highlighted by last week’s report from the EBA (European Banking Authority) on the impact of FinTech on payment and e-money institutions’ business models, the new post-PSD2 landscape is characterised by “new entrants offering innovative products and services” alongside “incumbents adapting and revamping their offerings”.

One thing European consumers seem to appreciate the most about challenger banks such as Revolut, Monese, Sterling Bank, N26, or Monzo – just to name a few that are already operational – is how convenient, intuitive and cheap their services are, especially in those jurisdictions where traditional banks might be lagging in terms of fee optimisation or digital solutions on offer.

In fact, according to a recent Mastercard study of 11 markets, more than half of European consumers say they will consider switching to a digital bank at some point. The same study revealed that one in five Europeans already utilises mobile banking apps from digital-only institutions.

Having established a solid presence in their home markets, some of the more ambitious European challenger banks are now looking to expand into Asia as well. For example, Revolut has announced plans to launch in Singapore and use the city-state as its gateway into the greater APAC region.  This is in part thanks to Singapore’s fintech-friendly regulatory environment, its extremely tech-savvy population and its pool of highly skilled talent.

The entrance of BigTech

But, newly established FinTechs are not the only organisations that traditional banks find themselves competing with in the payments space. As stated in the aforementioned EBA report, “a number of BigTech firms have already obtained Payment Institution/Electronic Money Institution [PIs/EMIs] licences, and existing players expect them to participate more actively in the EU payments sector”.

With BigTech firms such as Apple, Samsung and Facebook “posing a potential threat to the sustainability of PIs’ and EMIs’ business models, institutions are planning to focus on strengthening customer loyalty in case of increased participation of BigTech firms in the payments sector”, the report said.

Traditional institutions’ fears cannot be easily dismissed, if one considers what has happened across Asia in this regard. In China, Tencent, which owns WeChat, moved into payments as early as 2013. As reported by  The Economist, “uptake was slow until the company spied an opportunity in the tradition of giving cash gifts in red envelopes to friends and relatives during Chinese new year.”

“In 2014 it [Tencent] added a digital ‘red envelope’ feature to WeChat; 40m were sent over the holiday period. In 2015 an astonishing 500m were sent on the single busiest day,” the report said.

Meanwhile, in South Korea, one of only two virtual bank licenses was issued to Kakao Bank, operated by the Kakao, the company behind the country’s largest chat app. The other, K Bank, is operated by KT Telecom, Korea’s largest phone company.

Consumer expectations vs compliance requirements

However, as millions of consumers embrace digital banking and tech companies, emerging FinTechs and incumbent banks race to secure their market share, one huge complexity remains to address.

No-branch banking means no in-person, face-to-face contact. As such, traditional methods to meet all know your customer (KYC), anti-money laundering (AML) and due diligence requirements appear no longer fit for purpose.

Blinded by ambitious growth targets or by the fear of being left behind, organisations might be tempted to sacrifice their compliance needs in favour of faster customer onboarding and more seamless digital experiences. But as any of the big banks hit by big AML fines over the last few years can testify, this is not a sustainable approach in the new regulatory environment, where potential repercussions keep increasing for both corporates and individuals alike.

However, when implemented correctly, innovative regulatory technology (RegTech) can help firms active in the digital banking space bridge the potential gap between consumers’ expectations and compliance requirements.

By dynamically applying different sets of rules to customers based on the jurisdiction in which they reside, and building digital-first processes that seek to ensure higher security standards, RegTech solutions can empower FinTechs and incumbents alike to safely scale across markets in what is becoming an increasingly vibrant and fast-growing space.

Claus Christensen is CEO at Know Your Customer Ltd.

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