The GCC appears to be ripe for digital banking. There is a large, young, digitally native population often dissatisfied with conventional banks and with few options for a pure digital banking experience. A significant underbanked population also struggles to access traditional banking services, either because they are self-employed or have low incomes.
To capitalise on this, two digital banks – STC Bank and Saudi Digital Bank – recently secured licences from the Saudi Central Bank. In the UAE, Zand and ADQ’s as yet unnamed neobank have obtained licences to operate digital banks.
Lessons to be learnt
However, the promise of digital banking comes with peril. Experience elsewhere suggests the path to profitability for digital banks has been challenging, and that reality has not kept up with expectations.
To succeed, digital banks should internalise three lessons and respond appropriately.
The first lesson is that customer acquisition is tough. Dissatisfied though many people claim to be with traditional banks, they are remarkably loyal. Moreover, in the GCC the corporate relationship is very important. Many people use their employer’s bank, making changing banks unappealing.
The second lesson is that digital banks often have to spend lots of money to win customers. They use minimal fees – such as ‘freemium’ plans or new customer incentives – that take advantage of their lower cost structures compared with traditional banks. While this applies in developed markets, it may not work in the GCC.
Incumbent banks, meanwhile, possess underwriting and risk management capabilities that digital banks often discover are hard and costly to duplicate.
The third lesson is that after spending to acquire customers, many are inactive. Data from the UK show that few customers switch their primary accounts from incumbent banks to digital banks despite how easy it is now. Recent surveys show that less than 10 per cent of UK customers use digital banks as their primary financial institution.
That is a problem for digital banks since primary bank accounts are substantially more profitable than non-primary ones. Indeed, non-primary accounts often lose money. In banking, you always want to be the customer’s first account, the first card out of the wallet.
Going forward, we believe digital banks need to adopt tailored strategies. In the GCC, this means three complementary approaches.
First, digital banks can pick a customer segment and solve specific pain points, rather than seeking to compete across the entire retail market. A digital bank should solve distinct, stubborn problems to become a customer’s primary bank. For example, gig economy workers often do not have access to the same banking services as employees.
Digital banks could also choose to target micro and small companies that the financial system consistently overlooks. These companies often need value-added services such as cash-flow management and preparation of tax fillings.
Or digital banks could go after the employees of small- and medium-sized enterprises. In this way, digital banks can make more focused investments.
Secondly, rather than simply spending money to acquire customers (usually at a loss), digital banks should explore new pricing models to demonstrate a path to profitability through incentivising usage.
Instead of making money on lending products, they could charge a subscription fee, or offer a premium account that provides access to value-added services like metal cards, free travel insurance, free ATM withdrawals and partner offers. Monzo in the UK, for example, recently launched a premium account, complete with a metal payment card, for £15 ($21) a month.
N26 in Germany and Revolut in the UK plan to introduce low- and mid-tier subscription plans. These methods lower the risk of attracting loss-making customers who sign up for the incentive, but stay dormant.
Third, digital banks need to de-risk by exploring business models that help them compete more effectively against financial technology firms (fintechs) and GCC banks.
Many leading GCC retail banks have cost-to-income ratios of 30-35 per cent compared to 45 per cent or more in most developed markets. Incumbent GCC banks hold low-cost deposits due to religious concerns about interest earning.
In response, digital banks can partner with a third party to reduce the upfront investment and lower the break-even mark. Having the right business model can help a digital bank focus its capital expenditures on select features and domains instead of building an entire bank from scratch.
A digital bank could focus on offering “banking-as-a-service” to fintechs or traditional banks struggling to develop digital capabilities. Or it could offer a banking “super app” to third-party, non-financial services companies and earn commissions from generating leads. Another option is to develop embedded solutions for third-party platforms, such as online marketplaces and games.
Digital banking has promise in the GCC. Aspirant banks will need to tailor their approaches to the market carefully, combining the patience necessary to build a loyal customer base with the need to act as swiftly as possible.
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