The Philippines may see its first purely digital banks by 2022 as the central bank prepares to issue them licenses. But the challenge for the neobanks will be to build trust and convince customers in a country with low financial services penetration and a preference for face-to-face interaction, analysts say.

The Bangko Sentral ng Pilipinas in November 2020 approved a new license category for digital banks. The central bank has received two applications as of February — one from a new player and the other from an existing bank to convert into a digital bank, BSP's Deputy Governor Chuchi Fonacier told S&P Global Market Intelligence.

"Digital banks can help reduce the barriers that hinder financial access, such as the small and irregular income of clients, high transaction costs, geographical distance, and lack of proper documentation," Fonacier said in comments emailed on March 15. "The BSP sees digital banks as future partners in advancing financial inclusion in the country by leveraging on digital technology to offer financial products and services that bridge the market gaps in the unserved and underserved segments."

The Philippines has among the lowest banking penetration in Southeast Asia. The number of unbanked Filipino adults was estimated at 51.2 million, out of a total adult population of 72 million in 2019, according to the BSP's 2019 Financial Inclusion Survey released in 2020. However, the pandemic year also saw a spurt in financial inclusion as more Filipinos opened accounts to receive cash assistance from the government. BSP Governor Benjamin Diokno said in December 2020 that about 4 million new accounts were opened digitally from March 17 to April 30 of 2020 following the government's pandemic relief program.

The central bank sees the digital banking framework as an "integral component" of is efforts toward the transformation of the Philippine financial sector. It aims to shift at least 50% of all retail payment transactions to digital platforms and wants 70% of adults to have digital bank accounts by 2023, Fonacier said. "We expect Filipinos to benefit from new digital bank players offering more affordable financial products and customized financial solutions that are responsive to the diverse and changing needs of the market," she added.

Challenges for neobanks

A challenge for the neobanks will be to win consumer trust as they are starting from scratch, compared with incumbent banks that have already built their reputations over many decades, said Shweta Jain, director of digital and cloud product and strategy at Finastra. "Since neobanks are faceless and branchless, a powerful way for them to build consumer trust is by forging partnerships with local merchants such as, convenience stores, to enable some level of face-to-face interaction for things like payments and remittance services," she added.

Bernardi Susastyo, chief commercial officer of ADVANCE.AI, said digital banks will need to figure innovative products and services that meet consumer needs and trends. They will also have to deal with low internet penetration rates.

Apart from the relatively lower trust in digital products, the Philippines also faces infrastructural challenges, such as the absence of a single national ID, said Raphael Bick, a partner at McKinsey and Co. in Shanghai.

The central bank will support a strategic awareness program to educate the public on the range of available digital financial products, their risks and the rights of consumers, Fonacier said. The Philippine Identification System program using secure biometric data will help in the efficient delivery of digital financial services once it is operational. The PhilSys program is expected to improve the authentication and integrity of digital banking services, she added.

New guidelines

Under the BSP's guidelines, which took effect Dec. 23, 2020, digital banks will be required to have a minimum capitalization of 1 billion pesos and will be allowed to offer traditional banking services. They will not be allowed to establish physical branches and will need to maintain a head office in the Philippines.

Even before the new framework was announced last year, some companies tried to launch digital-only services under a rural banking license. That meant offering digital services alongside branches in non-metro areas. For example, Tonik Digital Bank Inc. received a banking license in February 2020 as a rural bank and plans to launch its new digital banking platform by the end of the first quarter of 2021. Rizal Commercial Banking Corp. in January 2020 announced plans to establish a wholly owned rural bank to engage in purely digital banking business.

TymeBank, a South African digital bank, has raised $110 million in private capital and partnered with local conglomerate JG Summit Holdings Inc. to apply for a digital banking license in the Philippines, Reuters reported on Feb. 22. Tyme is looking to use JG Summit's retail reach in shopping malls, groceries and pharmacy stores to reach customers. Others are also seeking to tap the digital space, with local boxing star Manny Pacquiao announcing two financial technology ventures in 2020.

"Virtual banks have a huge opportunity in the Philippines, where most of the country is young, online and without access to any banking services. Youthful demographics, a large untapped market, low costs and regulatory latitude make the Philippines an attractive market," Nikita Anand, an analyst at S&P Global Ratings, said.

Strong local banks

However, digital banks may find it challenging to chip away at the entrenched market positions of the traditional lenders given their strong franchise, particularly in the Metro Manila area, the nation's wealth hub. The top five banks in terms of assets in the Philippines handle about 60% of the country's loans and deposits.

"Digital banks will only meaningfully compete for the mass-affluent market if they provide significantly improved, and cheaper, products and services. Otherwise, while they may make inroads into specialized financing, their market share will remain small," Anand said.

Meanwhile, incumbent banks have accelerated their digital offerings. East West Banking Corp. launched its digital banking service Komo in May 2020. Union Bank of the Philippines started its digital transformation four years ago and introduced the country's first fully digital branch in 2017. Foreign banks operating in the Philippines such as CIMB Bank Bhd. and ING Bank NV have also announced purely digital products in the last two years.

Despite the challenges, neobanks have some advantages over traditional banks. Digital players typically have lower operational costs which allow them to offer higher deposit rates, Anand said.

Traditional banks "are lumbered with old, slow, unreliable legacy technology, while also having to deliver to much larger customer segments across many services," Finastra's Jain said.

Digital banks can move faster and innovate quickly and easily integrate new services, Jain said. "They may not take significant market share from incumbents in the first few years, but over a period of time they will start becoming the primary account holders for customers who currently hold primary accounts with incumbent banks," she added.

As of March 15, US$1 was equivalent to 48.62 Philippine pesos.