Welcome to virtual banking

Nicky Burridge
A report from Hong Kong FinTech Week 2018 on how business models of digital banks are ushering in a new revolution of financial inclusion

With the Hong Kong Monetary Authority issuing its first virtual banking licenses, Nicky Burridge finds out the benefits for consumers of digital banks and how the business models work after attending the Hong Kong FinTech Week 2018 conference this month

Imagine a bank that let you open an account in three minutes without setting foot in a branch, offered commission-free foreign currency exchange and kept track of spending for you.

It may sound unlikely, but virtual banks, such as Revolut, are doing just that.

Revolut does not have any branches. Instead, people can open an account through their mobile phone by sending a photograph of their identity document, filling in some personal details such as their address and nationality, and taking a selfie. The whole process takes a matter of minutes.

Revolut also offers real-time person-to-person money transfers and the ability to buy and store cryptocurrencies. Launched in the United Kingdom three years ago, Revolut now has 60,000 business customers and three million retail ones in 31 European countries, opening an average of 8,000 new accounts every day. It has raised US$340 million from investors and has a US$2 billion valuation.

Virtual banks, also known as digital banks or challenger banks, are a new breed of banks that do not have a physical branch network.

They will soon be coming to Hong Kong, with the Hong Kong Monetary Authority currently reviewing applications from 29 providers for virtual banking licences. “We think the next 12 to 24 months are going to be very exciting in Hong Kong,” says James Lloyd, Asia-Pacific FinTech Leader and Partner at EY.

Revolut also has plans to launch in a number of Asian countries, including Hong Kong, in the coming months.

The topic of virtual banks was discussed at the Hong Kong FinTech Week conference, which took place from 30 October to 2 November in Hong Kong and Shenzhen. The five-day event featured important announcements, presentations and panel sessions covering all key aspects of financial technology (FinTech), and involved experts from around the globe and some of the world’s biggest FinTech companies.

A new type of bank

Virtual banks have the potential to significantly disrupt traditional banking models, offer a better deal to consumers and improve financial inclusion.

Michael Gorriz, Group Chief Information Officer at Standard Chartered Bank, whose company has applied for a virtual banking licence in Hong Kong, explains that a virtual bank does more than offer its services through digital channels, such as a mobile phone or the Internet. Rather, it is a bank that is designed without bricks and mortar in the first place.

It focuses on the digital banking experience and provides the real-time service that people in the digital age expect. “This is not done just by putting a new digital face on your bank, you have to redesign banking from the ground up,” he says.

Lloyd points out that in Asia, digital banks are looking for new ways to service customers, such as taking messaging services and building a bank on top of them, as is the case with WeBank, China’s first online bank, which is offered through WeChat and QQ.

Virtual banks target two key customer segments. The first is consumers in rapidly developing countries, where the physical bank infrastructure has not kept pace with the growth in the middle class.

The second segment is millennials and digital natives in places like Hong Kong, who want a 24/7 service that they can access wherever they are. “They want a service that is ready for them when they want to do the banking and not the other way around,” says Gorriz.

In order to attract customers, virtual banks recognize that they need to offer them a better deal than their traditional counterparts. Revolut offers free worldwide travel insurance, and free instant international money transfers in 24 different currencies, while it is in the process of launching free stock trading. Foreign currency exchange is not only commission-free, but done at the interbank exchange rate.

Chad West, Chief Marketing Officer at Revolut, says: “People want clear added value, but banks have stung consumers in fees for years.”

Revolut also offers a number of innovative features, including budgeting tools, pay-as-you-go insurance, and state-of-the-art fraud detection systems. WeBank has similarly innovative features, and alongside other products, it offers microloans starting at RMB500 with interest rates charged of between 0.02 percent and 0.05 percent per day. The money can be repaid at any time.


Innovative business models

Virtual banks are able to offer these deals to their consumers because of their very different business models. Unlike traditional banks, they do not have the overheads associated with operating a branch network. They also typically use cutting-edge technology to automate processes that are carried out manually in other banks, enabling them to have a significantly lower headcount.

Henry Ma, Chief Information Officer at WeBank, explains that it uses artificial intelligence and chatbot technology to automate its customer services. “We use a lot of open-source technology, which means our IT operating costs are only one tenth of what incumbent banks are paying,” he explains.

“We use big data to drive a lot of the back- office processes, like risk management. This creates a vastly different cost structure to support the business model that we want to promote.”

Gorriz says in India, Standard Chartered has reduced the time it takes to sign up a new customer from seven days to just 15 minutes, using India’s open-source biometric national identity scheme. This has also reduced its costs of signing on new customers by 90 percent.

In addition to lower costs, some virtual banks also operate on a marketplace model, under which they cross-sell other financial products, such as insurance, to their customers, generating commission.

Another potential source of revenue is offering software-as-a-service to traditional banks, with some virtual banks “white labelling” the technology they developed, such as their anti-money laundering and anti-fraud systems.

But not all virtual banks have a full banking licence, with some, such as Revolut, operating as stored value facilities in the markets in which they operate instead, reducing compliance costs and restrictions. West says: “We can do 80 percent of what a bank can do, but we can build products without being held back by local regulation.”

Having the ability to scale quickly and expand into new markets and products is also key.

“You need to be able to easily scale up at a low cost. In less than four years, we were able to build a customer base of more than 80 million, and have launched more than 30 products,” says Ma.

He adds that virtual banks must also be agile to respond to developing market needs. “Our record from ideation to production took just 11 days.” Gorriz agrees: “In process design it is of upmost importance that we are fast. Speed is everything,” adding that Standard Chartered rolled out a virtual bank in four countries in Africa in just one quarter.

Even so, these business models are unlikely to be foolproof. “There are a lot of challenger banks now, but I think only a few key players will make it,” says West. “They will make it through speed and scale.”

“We use a lot of open-source technology, which means our IT operating costs are only one tenth of what incumbent banks are paying.”

Boosting financial inclusion

The development of virtual banks has significant implications for financial inclusion. TNG, which stands for The Next Generation and operates as TNG Wallet in Hong Kong, is specifically targeting this market.

Alex Kong, Founder and Chief Executive Officer of TNG, points out that nearly half of the world’s population does not have a bank account, including an estimated 1.2 billion people in Asia. “For users, our mobile app is like a mini bank in their hands,” he says.

The group does not have any branches, but customers can add cash to their accounts or withdraw money through Circle K and 7-Eleven stores using a QR code. The wallet can also be used to send money overseas, with recipients receiving an SMS with a payout code. They can then go to one of TNG’s partners, present their identification card and payout code and get the money.

“Our network covers more than 400 banks and more than 150,000 non-bank outlets where the unbanked can receive money instantly,” Kong says.

Internet giant Tencent has launched a similar service for domestic helpers working in Hong Kong called We Remit. The real-time remittance service operates through social networking site WeChat. It is free to use, and enables domestic workers to send money to their families any time, through their mobile phones.

Ashley Alder is the Chief Executive Officer of the Securities and Futures Commission.

Ride-hailing service Grab launched a financial services arm earlier this year to help boost financial inclusion in Southeast Asia. The group uses its drivers, which represent the largest online- to-offline distribution network in Asia, to facilitate transactions.

Reuben Lai, Senior Managing Director of Grab Financial Group, says: “These guys function as mobile ATMs and branches. They allow consumers to top up their GrabPay wallets and withdraw money from them. In Indonesia, if you take a ride in one of our cars, the driver asks if you want to top up your GrabPay wallet. The driver takes cash and transfers money from their wallet to the consumer’s wallet. Drivers like it because it gives them instant liquidity.”

He adds that acting as agents for Grab Financial enables drivers to boost their own incomes by 30 percent to 40 percent. Grab Financial also offers microloans to its drivers, using the data and insight it has on them to offer significantly lower rates than they would normally have access to – it also recently set up a partnership with MasterCard to offer virtual and physical prepaid cards to its platform users.

Virtual banking for businesses

Consumers are not the only ones who are set to benefit from virtual banks, with the new model also having implications for small- and medium-sized entities.

Neat, a local start-up, specifically targets entrepreneurs in Hong Kong, aiming to remove the obstacles they face opening a bank account. It enables them to open an account in 10 minutes through their mobile phone, using a digital know-your-customer process, for which it has won Best FinTech (Emerging Solutions/Payment Innovation) Silver Award at the Hong Kong ICT Awards 2017.

Once the account is open, businesses can link it to various payment gateways through which they get paid. David Rosa, Co-founder and Chief Executive Officer of Neat, says: “They can use that money to make domestic and international bank transfers to pay suppliers and employee salaries at the best exchange rate in the market.”

Neat also offers physical or virtual business credit cards, which can be managed through its banking app. When employees use one of the cards and takes a photograph of the paper receipt, it is automatically added to the online accounting system, saving companies’ time.

While it is still early days in Hong Kong, virtual banks are likely to present a significant challenge to their traditional counterparts. “When we started Revolut, every single person laughed at us. Banks laughed at us, investors laughed at us, friends and family laughed at us,” West says. “The idea that a scrappy little start-up could challenge banks with billions of dollars of assets, tens of thousands of employees and tens of millions of customers was laughable. Needless to say, they are not laughing now.” 

“They can use that money to make domestic and international bank transfers to pay suppliers and employee salaries at the best exchange rate in the market.”

Regulating cryptocurrency exchanges

The Securities and Futures Commission (SFC) has announced moves to bring crypto funds and exchanges under its regulation in a bid to enhance consumer protection.

Speaking at Hong Kong FinTech Week this month, Ashley Alder, Chief Executive Officer of the SFC, said Hong Kong had a sizeable population of investors who were interested in trading virtual assets, while there was also growing demand for funds that invested in them.

He said the SFC would be introducing new requirements for fund managers that it already supervised who intended to invest more than 10 percent of a mixed portfolio in virtual assets.

He added that for the time being, only professional investors would be allowed to participate in these funds.

Alder said that while the SFC’s reach did not extend to the managers of pure crypto funds, companies that distributed these funds would have to be registered with it or licensed by it as brokers, and they would have to comply with its distribution requirements.

“The combined effect of these measures is that the management or distribution of crypto funds will be regulated in one way or another, so that investor interests will be protected either at the fund management level, at the distribution level, or both,” he said.

The SFC is also exploring the potential regulation and licensing of crypto exchanges. Interested operators will be able to opt in to trying the conceptual framework within a sandbox environment to enable the SFC to assess if it would be appropriate for it to regulate them. “If, and only if, we decide at the sandbox stage that we should regulate, we would consider granting a licence,” said Alder.

He added that the exchange would then be subject to intensive reporting and monitoring to ensure it had strict internal controls and that investors’ interests were protected. 

The Hong Kong Monetary Authority recently launched eTradeConnect in September, a new blockchain-based banking trade finance platform, in a move to expand its presence within the city’s FinTech sector. The platform combines the services of 12 major domestic and international banks and connects with another blockchain platform to facilitate more efficient trading among a network of 14 European banks.

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