On January 13, 2023, the State Bank of Pakistan (SBP) issued five retail digital banks (RDB) No-Objection Certificates. The SBP communication advised that the successful applicants were Easypaisa Digital Bank (Alipay and Telenor), Hugo Bank (Getz, Atlas, and M&P), KT Bank (Kuda, Fatimah Fertiliser, and City School), Mashreq Bank, and Raqami Islamic Digital Bank (PKIC, Enertec, and Planet N). It also stated that it expected RDBs to promote digital financial services to the financially excluded.

This market had been waiting anxiously for this announcement. There had been 23 applicants chasing the five licenses. Applicants included giant commercial banks, international digital banks with local partners, and savvy fintechs that raised capital for this purpose.

The SBP, in its wisdom, did not entertain any commercial bank as it felt that they already had a license which allowed them what the new license would. The valuation argument by the commercial banks did not hold much water with the SBP.

This was not surprising given the meagre financial inclusion (less than 1.5 million active loan customers) and convoluted customer journeys due to a lack of back-office automation.

Time will tell if the licenses issued by the central bank will succeed like their microfinance licenses or never take off

The retail digital banks have their work cut out for them, as both the SBP and the market have high expectations of them. The sponsors of these banks are also required to invest a minimum of Rs50 billion over the next two years.

However, if the digital banks take off, this number could easily be Rs200bn over the next five years. So what are the top three actions the retail digital banks must get right to move the financial inclusion needle?

First, digital banks must demonstrate scale in the financially underserved segments. These segments include but are not limited to small and medium enterprises, women, students, agriculture, and gig workers. To be deemed successful, the five digital banks over the next three years must reach a minimum target of at least 10m active loan customers.

Currently, the active loan customers for commercial banks (1.5m) and microfinance banks (9m) stand at around 10.5m. This implies doubling the existing number. No easy task. However, this target is definitely possible with the right vision, tools, and execution ability.

The digital banks must be led by segments, must develop products based on the customer lens, and must measure success by customer satisfaction as opposed to the bottom line.

Since other than Easypaisa Digital Bank, all others are starting from scratch, they must have an open API approach. They should leverage companies with scale, customer data, and technical readiness. They should consider offering their balance sheet as a platform instead of the relatively closed-loop stance of the commercial banks, where an enterprise integration can take up to nine months.

The open API requirements should be pre-determined on their website, and the integration timeline should be within a week. Given the weak economic environment, digital banks should consider closed-loop lending with short tenors and small ticket sizes. As their algorithms learn, the exposure can be increased.

The RDBs must materially change the customer journey for all their potential customers. This aspect and the use of big data and AI will be key determinants allowing the newly minted RDB to compete with established brick-and-mortar commercial bank brands.

The commercial banks, despite trying, are yet to harness the gold mine of customer data they have for new-to-industry customers. They have also yet to automate the back office. This is their Achilles heel. A new-to-industry credit customer has to wait a month at best to get approved; a private limited company or a partnership can take up to 60 days to get a checking account.

RDBs do not have legacy systems and can build data warehouses from scratch and automate their back end from day one. RDBs should strive to be paperless with no manual processes.

The third pillar of RDBs must be their tech stack’s robustness and defences against hacking and financial fraud via phishing. Pakistan is in the middle of its digital journey. Most are unfamiliar with data security and can easily be convinced to share their password and other proprietary data.

RDBs can reduce the risk of hacking by moving to a tier-four cloud provider rather than on-prem data centres. However, they will have to educate their customer base about financial fraud.

The RDBs have a limited window of opportunity to execute their plan before the commercial banks raise their game. Time will tell if the RDB license issued by the SBP will succeed like their microfinance licenses or never take off like the Payment System Operators and Payment Service Providers licenses.

The writer is the Chairman of the Pakistan Fintech network

Published in Dawn, The Business and Finance Weekly, July 31st, 2023

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