What will it take to win in the age of digital banking?

Hong Kong is set to witness the launch of its first virtual banks following the recent issuance of eight licences by the Hong Kong Monetary Authority (HKMA). These new players are expected to broaden the selection of banking options, foster innovation and enhance customer experience in the city. Moreover, the new entrants will be vying to increase their market share and customer base, while the incumbent traditional banks will seek to maintain their standing in the market. Navigating this competitive landscape will require new ways of thinking and new strategies to enhance the overall banking experience and to win over customers. 

The unbundling and rebundling of banking services

In the longer term, the development of virtual banking in Hong Kong forms part of a larger ‘unbundling’ story in the banking sector. Many new fintech firms – and now the virtual banks – focus on discrete functions and services along the value chain that traditional banks offer, for example in payments, lending or money transfers. Focussing on an individual segment enables them to exploit the pricing and customer experience gaps left by the traditional banks.

Our view is that this unbundling will eventually lead to a ‘rebundling’ of services in new and innovative ways as customers will ultimately prefer to use a single efficient interface for all of their banking needs. This rebundling will lead to a smaller number of winners in the market, likely comprising the few traditional banks that are able to adapt to digital technologies and open banking, new virtual banks and fintechs that are able to knit together seamless services through APIs and other technologies, or some form of hybrid.

From a medium-term perspective, the outlook for the new virtual entrants could move in two directions. The first could see the widespread adoption of virtual banks as secondary banks, where they take a large share of payments and other non-balance sheet business such as wealth and insurance. Many parts of the landscape, such as mortgages and other balance sheet business, would likely remain untouched.

The second scenario is that the new virtual banks fail to convince customers of their value proposition, resulting in high acquisition costs, while the major traditional banks are able to create successful digital propositions much faster than anticipated.

The most likely scenario in the medium term is likely to be somewhere in the middle, with virtual banks winning over a considerable number of customers, but only a minor share of banking assets. Nonetheless, it is certain that the road ahead will be fiercely competitive, and both traditional banks and the new virtual bank entrants will need to develop a strategy for success in Hong Kong, which will include a mix of offence and defence. Overall, customers stand to be the real winners.

What it will take to win: Traditional banks        

For traditional banks, a defensive approach entails looking through the value chain to understand where they are vulnerable to disruption – as well as what their customers think about their existing processes – and focus resources on developing appropriate countermeasures.

An offensive strategy involves understanding and exploiting the areas where they might have a competitive advantage over their virtual bank peers. Traditional banks, which have a significant amount of capital and large customer bases, could seek to build completely new platforms for themselves, or capitalise on their inherent advantages by delivering a consistent and seamless experience across physical and online channels.

Importantly, bank branches are still valuable to customers – even those who are digitally savvy – especially for high-value transactions (e.g. higher margin and wealth management and mortgage products). For example, KPMG China’s Customer Experience Excellence Survey[1] finds that customers, particularly in Hong Kong, still value human interaction.

Successful execution for traditional banks will also rely on their ability to better understand their customers and adopt a more customer-centric approach, which will require rapid IT and systems transformation. Existing banks will need to invest in new technology and upgrade their digital platforms to effectively compete with the new market entrants. For example, we will continue to see more banks offer electronic onboarding and customise their digital banking user experience.

What it will take to win: Virtual banks

We know from our work with virtual banks in Hong Kong that they have already developed their differentiation strategy and innovative products. Now, for the successful applicants, the focus is on seamless execution. In order to be successful, virtual banks will need to effectively recruit the right people, put in place the necessary systems, processes and controls, and quickly plug into the local ecosystem all within the next six to nine months. Meeting regulatory requirements and ensuring cybersecurity will also be crucial. Any regulatory or data and cybersecurity setbacks early on could potentially have a serious negative impact not just on the organisation, but also on the reputation of the whole sector.

Virtual banks are also expected to have a competitive advantage over traditional banks with respect to costs and digital infrastructure. For example, virtual banks are likely to enjoy cost and operating efficiencies in the KYC process, particularly through digital onboarding. Virtual banks are also not constrained by legacy systems and infrastructure that have hindered some traditional banks. However, if the execution of their strategy is below par, even virtual banks which are assumed to have a cost advantage may fail to overcome the scale advantages of traditional players.

Cultivating an environment for digital banking

Hong Kong’s digital banking landscape could follow a similar path to other jurisdictions like the UK, where virtual banks have been steadily building their customer base over time. Furthermore, the HKMA’s initiatives to usher in a new era of Smart Banking, coupled with the opportunity to enhance customer experience in the banking sector, is creating an environment for digital banking to thrive in Hong Kong.

In particular, the Faster Payment System (FPS) – which was launched by the HKMA in September 2018 – could be a game changer. It will be interesting to see to what extent the further adoption of FPS for retail payments shifts Hong Kong towards a more cashless society over time, and the extent to which it opens opportunities for virtual banks and traditional banks alike to enhance more direct competition with e-wallets.

If you would like to know more about our perspective on Hong Kong’s banking sector in 2019, please read the full report here.

Co-authored by Tom Jenkins, Partner, Head of Financial Risk Management and James Harte, Director, Global Strategy Group

[1] ‘Customer first – Building a trusted and connected customer experience in China’, KPMG China, October 2018, https://home. kpmg.com/cn/en/home/insights/2018/08/customer-first-building-a-trusted-and-connected-customer-experience.html