The State Bank of Pakistan (SBP) recently issued its guidelines for digital banks for public consultation. The draft guidelines cover both digital retail banks (dealing with retail customers) and full digital banks (offering services to corporate customers).

Digital banks can have a profound effect on financial inclusion. If executed properly, the idea can change the customer journey by reducing paperwork, providing services remotely and leveraging customer data.

On the face of it, Pakistan offers a major opportunity for such an intervention. Firstly, we are a “cash society”. We have about Rs4.6 trillion in circulation. This means money printed but not in any bank account. Secondly, our median age is 22. Total telephone subscriptions have now risen to 183 million with the number of smartphones rising to 89m.

The regulations for digital financial interventions are also quite advanced compared with those in other emerging markets. Payment regulations enabling non-banks exist via electronic money institutions (EMIs) and the latest sandbox of the Securities and Exchange Commission of Pakistan (SECP)–piloted peer-to-peer lending. Despite favourable aspects, it is highly unlikely that digital banks will be able to move the needle. Let us examine the causes for this pessimism.

Digital banks that have a path to profitability offer digital lending, personal finance management and robo-advisory

Global success stories of digital banks like Monzo, Revolut, Atom and Moven indicate that the principal service that these banks started with was the ability to open an account remotely, followed by the ease of payments and personal finance management.

Customers wanted an alternate to the paper and physical journey that commercial banks demanded. Their revenue model is based on debit cards. They charge a fee, ranging from 1.5 per cent to 2.5pc, on every transaction that the customer performs. Given the great customer journey these banks provided, they quickly gained traction. This meant revenues increasing exponentially and, as a result, the banks’ valuations also rose.

Unfortunately, with the advent of the pandemic, the transaction volumes dropped and led to an increase in their loss numbers. Most, if not all, digital banks — like e-commerce companies — have great valuations, but they lose money.

Moven, one of the globally touted digital banks, is shutting down. Founded in 2011, it was the new breed of mobile-only, low-fee banking app provider with a sassy anti-bank attitude. The company at its peak was valued at $416m, but it continued to have major losses. Due to its funding drying up, it was forced to shut down.

In Pakistan’s case, while the need exists to significantly improve the customer journey, we need to look at the development of use cases, infrastructure and the appetite for local players to sustain losses. The biggest use case that exponentially increases transaction volumes is the physical purchases at retail stores. We have yet to build a material retailer network that accepts digital payments as opposed to cash. While e-commerce transactions and person-to-person transactions are growing, they will not provide the tipping point where revenues turn into profit.

In fact, with the current arbitrage available to branchless banking merchants, both payment giants — Jazz and Easypaisa — lose money. Also, the infrastructure must allow a pull payment transaction i.e. when you sign up for a magazine subscription, the merchant can take money directly from your account after your consent.

The SBP payment service, Raast, will provide this, but it does not currently exist. All this suggests the bank will experience big losses before making a profit. Do investors have an appetite for this?

Digital banks that have a path to profitability have included digital lending, personal finance management and robo-advisory in the service menus. In Pakistan, digital lending by commercial banks is practically non-existent. It still takes over a month to get a credit card to a “new to industry” customer. Digital lenders to individuals other than the two telco banks have yet to take off and merchant lending has only one success story. Pakistan boasts only one personal finance management app that has gained traction and a couple of robo-advisers.

For digital bank players to have any impact on financial inclusion and the customer journey, regulatory changes, collaboration, tax breaks and customer education need to take place. Firstly, the SBP needs to review its capital requirement of Rs4 billion for digital banks. If the SBP is comfortable with microfinance banks (with their ability to take deposits from anybody) being capitalised at Rs1bn, why should it make the distinction?

Secondly, commercial banks have been singularly unsuccessful in driving the customer journey. With the fear-of-missing-out driving them, they would benefit from the high capital requirement — they are long on capital but short on innovation.

The only win-win would be a collaboration with fintechs. A merchant acceptance eco-system is unlikely to take off fearing the Federal Board of Revenue. A tax holiday for digital transactions must be considered to jump-start this eco-system. The potential for creating a unicorn exists for those who can connect the dots.

The writer is a tech entrepreneur

Published in Dawn, The Business and Finance Weekly, May 24th, 2021