What a digital bank is, and why regulators license it separately

A bank that works through electronic channels

A 2020 paper by the Financial Stability Institute of the Bank for International Settlements describes banks engaged in digital banking as deposit-taking institutions that are members of a deposit insurance scheme, and that deliver banking services primarily through electronic channels instead of physical branches.

Regulators in the region use similar words. The Hong Kong Monetary Authority defines a virtual bank as a bank which primarily delivers retail banking services through the internet or other forms of electronic channels instead of physical branches. Bank Negara Malaysia's 2020 framework refers to banking business carried on wholly or almost wholly through digital or electronic means. The Bangko Sentral ng Pilipinas, in its 2020 guidelines, describes a digital bank as one that offers financial products and services processed end-to-end through a digital platform or electronic channels.

Deposits are what make it a bank

The same BIS paper sets digital banks beside two other fintech models. Fintech balance-sheet lenders do not take deposits, so they have to rely on other sources of funding. Crowdfunding platforms match borrowers with investors so that the platform itself does not undertake any risk transformation. A digital bank is different because it takes deposits from the public and lends them out.

That is why the paper notes that most jurisdictions apply existing banking laws and regulations to banks regardless of the technology they use, and that, once licensed, digital banks generally face the same ongoing requirements as traditional banks. The channel is new; the promise to repay depositors is the same. How lenders without deposits are organised is the subject of the course on fintech business models.

Two approaches: the same licence, or a dedicated one

Regulators have taken two paths. The first is to license a digital bank under the ordinary banking licence. The European Central Bank's 2018 guide on fintech bank licence applications says that fintech banks must be held to the same standards as all other types of credit institution, and that the guide is technology-neutral.

The second is a dedicated licence with its own entry conditions. The BIS paper, based on a review of regulations and a survey carried out in early 2019, found such frameworks in only a few jurisdictions: Chinese Taipei, Hong Kong SAR, Korea, Singapore and the Abu Dhabi Global Market, all in effect in 2018 or 2019, with Malaysia expected to follow. Malaysia issued its framework at the end of 2020, and the Philippines issued its guidelines the same month. Even under a dedicated licence, the paper found that the main licensing and ongoing requirements are similar to those for traditional banks; the differences lie mainly in technology, the business plan and limits on physical presence.

Why create a separate licence

The regulators state their reasons. The Hong Kong Monetary Authority expects virtual banks to promote fintech and innovation, to offer a new kind of customer experience and to help promote financial inclusion. When it announced up to five digital bank licences in 2019, the Monetary Authority of Singapore said the new players could cater to under-served segments and spur existing banks to keep enhancing their digital offerings, adding diversity to the banking system. Bank Negara Malaysia's framework aims to let digital banks serve underserved or unserved markets, while safeguarding financial stability and depositors' interests.

So a dedicated licence is a policy choice: competition and inclusion on one side, depositor protection on the other. That balance explains most of what follows in this course, from who may apply to why new digital banks often start with limits.

Southeast Asia beside other regions

Placed against other regions, using the frameworks the BIS paper surveyed and the regulators' own documents, the picture looks like this.

• East Asia. Korea, Hong Kong SAR and Chinese Taipei had dedicated frameworks in effect by 2019, according to the BIS paper. Korea's internet-only banks were restricted to retail customers and small and medium-sized enterprises.
• Southeast Asia. Singapore announced its digital bank licences in 2019; Malaysia and the Philippines issued their frameworks in December 2020.
• Europe. In the euro area, the European Central Bank's 2018 guide holds fintech banks to the same licensing standards as all banks. In the United Kingdom, as the BIS paper described in 2020, a newly authorised bank could take a mobilisation route and complete its build-out under restrictions.
• Oceania and the Middle East. As the BIS paper described in 2020, applicants in Australia could use a restricted licence for a transitional period, and the Abu Dhabi Global Market had a dedicated digital bank framework.

Two limits apply to this comparison. The BIS paper describes frameworks as of 2019 and 2020 and covers a selection of jurisdictions, and frameworks are revised. The lending rules that apply in each market now are on the rules pages for each market and in the rules comparison.

Four questions to place any digital bank licence

• Who may hold it: which owners, and with what track record?
• What may it do: all customers, or only some segments such as small businesses?
• Where may it be present: no branches at all, offices only, or access to shared cash networks?
• How does it start: with full status from day one, or in a restricted phase with caps on deposits, assets or products?

Lesson 2 takes the first question and what regulators ask of applicants; lesson 3 takes the last one.