Digital Banks and Future Direction

Kompas/Priyombodo

Residents show messages offering online loans in Tangerang, Banten, Thursday (23/9/2021).

The Covid-19 pandemic has changed the way people conduct their activities. WFH, or working from home, is now a common term. Apart from working and learning from home, people also conduct various other activities at home, such as watching movies, playing online games, shopping, learning to cook, as well as getting a health consultation.

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In the financial market, the increase in online economic activities is reflected in the increase in the share prices of a number of digital services companies. The share price of e-commerce company Amazon increased 74 percent from January 2020 to early October 2021, during the peak of the pandemic. The share price of subscription-based entertainment streaming service Netflix rose 89 percent, while shares in videoconferencing platform Zoom rose 800 percent in 2020.

Most payment and investment activities curing the pandemic were also done from home. Shopping from home requires a digital payment facility. The share price of financial technology (fintech) payment services company PayPal increased 175 percent with a market capitalization of US$305 billion, or around a quarter of Indonesia's gross domestic product (GDP). Digital payments processing company Stripe Inc., founded 11 years ago, presently has a capitalization of $95 billion, a threefold increase during the pandemic.

Retail investors are attracted to buying shares in companies and some banks that claim to provide digital services.

The phenomenon of soaring share prices of digital services companies has also spread to Indonesia. However, the majority of Indonesia's digital services companies, most of which are still funded by private investors, are not yet listed on the stock exchange. Investors are also hunting for listed companies or banks that have the capacity to operate in the digital economy. Retail investors are attracted to buying shares in companies and some banks that claim to provide digital services.

The increase in the share prices of small banks in Indonesia that claim to be digital banks is indeed extraordinary. This is because there is an expectation that digital banks will prosper in the future. Bank Jago's market capitalization has reached Rp 209 trillion to surpass the combined market capitalization of Bank BNI, Bank BTN, Bank CIMB Niaga, Bank Danamon and Bank Panin, although Bank Jago has total assets far below these banks. In another example, the market capitalization of digital bank BRI Agro has reached Rp 50 trillion. Meanwhile, Bank Aladin's market capitalization has booked Rp 39 trillion, already surpassing the market capitalization of Bank BTN, or of CIMB Niaga, Danamon, and Panin.

Profit expectations

According to financial theory, stock prices reflect expectations for a company's earnings performance. Will the profits of digital banks in the next 10 years to overtake those of conventional banks?

KOMPAS/BENEDIKTUS KRISNA YOGATAMA

Online loan victims who complained to LBH Jakarta are demonstrating in front of the Metro Jaya Police Headquarters, Saturday (23/3/2019)

Digital banks target the generation familiar with technological developments, namely the millennial generation. As they are still young, they are usually not large sources of bank deposits. However, in the next 20 years, the millennial generation will become highly paid professionals or established entrepreneurs.

Will conventional banks continue to remain silent, watching as digital banks snap up millennial customers? That is why a number of large banks like Bank Mandiri, BCA, CIMB Niaga, and OCBC NISP are increasing their digital capabilities. If the customers of large banks can make deposits, buy and sell shares, buy insurance and mutual funds, and take out vehicle loans and mortgage loans, on the mobile phones in their hands, they will not switch to another bank.

Therefore, digital banks must work together with other parties in order to set up an ecosystem, for example for e-commerce, transportation services, agriculture, and micro entrepreneurs.

On the other hand, it is actually not easy for small banks that claim to be digital banks to attract customers in a short time. Banks make their profits from accumulating deposits from their customers and channeling them as loans. Banks also derive their profits from non-interest income sources, for example by providing money transfers, foreign exchange trading, and investment services. Therefore, digital banks must work together with other parties in order to set up an ecosystem, for example for e-commerce, transportation services, agriculture, and micro entrepreneurs.

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In establishing an ecosystem, it is expected that customers will open bank accounts and conduct various transactions through their accounts. In order to create room to focus on digital banking, two big banks, BCA and BRI, have resorted to a strategy to set up a digital bank subsidiary with hopes of diversifying its customers, and that their existing customers will move to these subsidiaries rather than to other banks.

In principle, a digital bank is a bank that does not have branch offices or provide ATM services. All transactions are carried out online via mobile phones. Because digital banks are trying to develop an ecosystem, they should have a technological system that connects to a number of parties for interconnection and interoperability.

DIDIE SW

Didie SW

For example, to disburse personal loans, banks need information on their customer’s ability to repay loans, such as transaction data and loans from other banks. Here comes the term “open banking” through standardized API (application programming interface). Bank Indonesia has set API standardization.

What must be protected from open banking is data, so that there is no misuse of customer data.

In order to retain customers, conventional banks have also begun to realize the importance of collaborating with actors in the digital economy. For example, if millennial customers want to buy mutual funds, it will be better for them to deal with a fintech company that specializes in small mutual funds.

Conventional banks have also opened their doors to cooperation with fintech companies that provide electronic money (e-money) services, because bank customers are now more comfortable with using e-money to pay for various retail transactions. Conventional banks have also opened their doors to cooperation with digital lenders in order to grow their microcredit and consumer loan portfolios.

With the advancements in technology, various transactions and data storage can be carried out online networks, so cybersecurity threats should be monitored closely and prevented from happening. Even if the threat becomes a reality, there is a technology to recover from it.

Two regulators, the Financial Services Authority (OJK) and Bank Indonesia, have regulated security standards, governance and risk management for information systems, which are very important to digital banking services. Banks and other players in the digital economy must be ready for cybersecurity threats, but regulators must also be ready with a new skill: using technology to carry out supervision and inspections.

Welcome to a new era, the digital economy era.

Kompas

Mirza Adityaswara

MIRZA ADITYASWARA is president director of the Indonesian Banking Development Institute (LPPI).

(This article was translated by Hendarsyah Tarmizi).