In Punjab’s rural south, landlords of nobility stature and ones that are moneyed are received by bank managers at their respective branches. Donning boski suits with a coterie of servants around, these landlords are escorted to the manager’s office instead of queuing up at the branches. Drinks are served and the manager treats them with respect deserving of their nobility, and money. Their paperwork is filled on priority, their loans approved in an instant and the manager will favour them in matters outside the bank as well. Building a personal relationship with such customers helps the manager get deposits from these landowners who are wealthier than many of the other bank customers.
Outside the manager’s office, the average farmer stands in line to deposit his cash and his loans are most likely not going to be approved because of an uncertain income. Outside the bank, a farmer would not even be allowed entry into the bank because of how he looks.
Barring the landlord, the other two types of customers are what keeps the policymakers at the central bank up at nights. One of these is the underbanked which gets to have an account at the bank but has limited access to financial services. The other is unbanked, which has no account at all for one reason or the other. So if you are a central bank that has to ensure that constraints for both these types of customers are removed, what do you do?
In 2022, the answer to everything seems to be technology. In the financial sector too, financial technology companies have entered the foray to solve problems related to banking the unbanked. In Pakistan, the fintech companies are only starting. In January this year, the State Bank of Pakistan introduced the Digital Banks Regulatory Framework to solve the problem of financial inclusion which is broadly caused by the unbanked and the underbanked segments of the population.
Following the regulations, the SBP received twenty applications for a digital banking licence. The applicants include domestic commercial banks, microfinance banks, electronic money institutions and fintech companies, as well as foreign financial institutions already operating in the digital banking space in other markets.
One of these applicants is Tajikistan-based financial technology company Alif Bank which operates as a digital bank in the home country and has a presence in Uzbekistan where it offers digital financial services. It now seeks entry into the Pakistani market and aspires to get a digital banking licence. Alif is in-fact the only fintech company to come out openly with what it plans to do under the newly introduced digital banks regulations. Alif’s plans for the Pakistani market also give a glimpse into the good and bad for digital banks and what the Pakistani market holds for not only Alif but rest of the aspirants as well.
A brief history of Alif Bank
Alif Bank was founded in 2014 by Abdullo Kurbanov, Firdavs Mirzoev and Zuhursho Rehmatulloev as a microcredit organisation in 2014. The entity was initially called Alif Capital. Within nine months of operations, Alif managed to triple its loan portfolio and became the fifth largest microcredit organisation in Tajikistan.
In 2016, Alif received the licence as a Microcredit Deposit Organisation (MDO), allowing Alif to open deposits, conduct exchange transactions within the country and abroad, and to provide broader financial services, essentially making Alif a mini-bank. Later that year, Alif ventured into the online world with the country’s first online acquiring platform which allowed cardholders to make payments online. The same year, Alif also launched an online shop which allowed customers to buy goods on instalments. This was Alif’s advent into the buy-now-pay-later segment (BNPL) and the online shop also went on to become the largest B2C marketplace in Tajikistan.
One of the biggest achievements that Alif claims for itself is writing its own core banking system, as well as all other major systems which makes it self-sufficient and stable. In 2018, Alif launched its fully in-house developed mobile wallet called Alif Mobi which is now the largest and most widely used mobile wallet in the country, according to the company, and in 2019, the company entered the Uzbekistan market with BNPL offering and lately launched its mobile wallet – all Shariah compliant.
It has now scaled to a bank in Tajikistan after securing a banking licence in January of 2020 and planning an expansion into markets beyond Tajikistan and Uzbekistan.
“In 2021, we concluded that we have very strong managers in Tajikistan and Uzbekistan that can take over daily operations and the co founders should now focus on exploring new markets to enter and launch products in,” says Firdavs Mirzoev.
“In September 2021, the first country we visited for the purpose of exploring was Pakistan. We looked at different indicators and after two weeks of research and being in Pakistan, we were very positive about this market. In January 2022, the SBP announced Digital Retail Bank regulations which reinforced our commitment to enter Pakistan because you need proper regulations in place to make it work,” Firdavs says.
Today, Alif says it is the market leader in BNPL segment, mobile payments and mobile remittances in Tajikistan, one of the leading BNPL service providers in Uzbekistan and has about a million users in two countries and a significant revenue run rate.
It aspires to provide a similar digital ecosystem of payments, BNPL, short term lending for consumers and SMEs and cross border remittances under its Digital Retail Bank licence applied for in Pakistan.
Understanding the opportunity for Digital Banks in Pakistan
Coming to our earlier mention of landlords, the banks, because of their presence in the financial services for decades, have managed to find ways to attract deposits from the wealthy in Pakistan. In another example, Habib Bank’s Prestige Branches give an exclusive and luxurious treatment to its rich depositors. This exclusive treatment is loved by the ultra rich and makes them stick with their bank. While it may sound conjectural that the digital apps might not be able to eliminate the divide between the rich depositors and not-so-rich depositors, it might not totally be an unrealistic scenario.
Nonetheless, conventional banks have their rich depositors firmly in place for now. These banks have also dominated the middle-income segment attracting these deposits through salaried accounts. According to a top banker, banks are also very efficient at securing salaried accounts.
The deposits that are attracted from these sources are used in lending to make money for conventional banks. While banks attract bulk of the deposits from consumers, the bulk of the bank lending, however, is done to corporate clients and the government. As a consequence, Pakistan’s consumer financing has been only 1% of the total financing by banks in Pakistan.
Lack of financing for consumers is what makes the banked underbanked: there aren’t enough consumer financing products for retail customers of commercial banks. “Banks only have credit cards or personal loans for most consumers and auto loans and home loans for the salaried class,” says Mahmood Shamsher, country head for Alif Bank in Pakistan.
For digital banks, the opportunity to serve customers lies in lending and value added services. Corporate and government lending, however, are saturated and clutched by legacy banks, leaving only consumer and SME financing open for rest of the players. Both these segments have not been penetrated by legacy banks for one reason or another.
Services such as P2P payments, bill payments and bank transfers are hygiene factors, according to a banker, which have to be provided in a robust manner and can not be considered as the basis for creating commercial viability.
On the other hand, the sources of deposits for any new entrant are significantly less. Officials at Alif agree with the assumption that there is uneven distribution of wealth in Pakistan and that the top 10% occupies majority of the wealth which have been occupied by banks and form the Rs17 trillion worth of total industry deposits. What they further agree is that it is going to be a while before any digital bank would be able to tap into the deposits of legacy banks.
“Commercial banks have been there for decades and they have created the trust with their depositors and it would be a while before digital banks are able to build a similar trust,” says Firdavs.
The other avenue to attract deposits for the digital banks remains the bottom 90% of the depositors which occupy only 10% of the wealth. These are the financially excluded which the banks do not chase because serving them comes at a cost higher than the money that can be made off of them.
The challenge is going to be managing the need to raise deposits, particularly with the unbanked, and doing so economically. To be able to offer a range of other financial solutions for the unbanked. Including BNPL, which is an age-old problem with a modern technological solution. The credit scoring and the access to customers with a range of products and services, means the ability to also deeply understand and serve SME. Also a possibility with a digital banking license. A space that has long been ignored.
The problems do not end here, however.
On the lending side, the case of microfinance banks shows that lending to customers such as SMEs has resulted in high NPLs for these microfinance banks and consequently high interest rates. On the BNPL side, one of the leading BNPL startups has rolled back its operations in Pakistan because of a high default rate of customers and merchants’ lack of understanding of technology.
“Our focus now is on a different market now for BNPL where these barriers are less forceful,” an official from the company told Profit. “We entered with great ambition but realized that Pakistani market was not mature yet for a technology driven BNPL service,” he said.
Firdavs recognises the concern and allays it by saying that no one formula is guaranteed for success. “What we will bring in the space is the expertise of doing similar things in very similar markets,” he says.
“In terms of economic developments, in my view, Tajikistan and Uzbekistan would not be that different from Pakistan. The challenges for emerging markets are to some extent similar. Nonetheless, it does not mean that if one of your products becomes successful in one market, you would replicate that in the other market and that would be a success, especially in financial services,” he adds.
The key to success, according to him, is to improve by way of testing. “You have to be flexible and ready to change your products and offerings on the fly. It is very difficult to say how a particular product of Alif will be successful in Pakistan compared to how successful they are in the current markets. We have some assumptions that certain product of ours might do well in Pakistan, while the others might not, however the only way to get a proper answer to that is by way of proper testing and adjustments,” he adds.
Alif officials think that one way digital banks are going to have a better success rate of digital financial services is that at their core, they would be technology companies with banking licenses, and any innovations in the product, which will directly impact chances of success are going to happen in weeks and maybe even days, instead of months in the case of banks. So the success of digital banks is really going to be contingent upon how friendly the app user interface and experience are, besides solid investment in absence of certain deposits and the ability to absorb losses.
The threat of the incumbents
Access to a digital bank license has not been restricted by the central bank to fintech companies or any particular type of financial institution. It is in-fact a free for all license in which the legacy banks have been given the space to apply as well and some of the contenders for the license include some of the big banks in Pakistan. HBL, UBL, Bank Alfalah, to name a few.
If in fact the digital banks are able to establish themselves in smaller segments such as BNPL or SME lending, banks that have the digital bank license would enter the same segment with better resources. Even if the banks do not get a digital bank license but see digital banks make headway in smaller segments, they might pull together their resources to enter the smaller segments too to keep their competitors from getting big enough to threaten their deposits in the future.
At the same time, the smaller segments that digital banks would enter into would saturate very early on because these smaller segments would have to be shared by multiple digital banks. “What is foreseeable is that the small segments that these digital banks would move into would form a smaller chunk that would be shared by multiple competitors,” says a top banker.
“If a fintech company pumps in an equity of Rs2 billion and builds a book of Rs20 billion out of which it is able to lend Rs13-14 billion, it looks doable. But multiple fintech companies doing the same in one segment would not mean each player would be able to lend Rs13-14 billion in that segment,” he adds.
And if the incumbents try to enter as well, being rich on resources mean that even if for instance a bank like Habib Bank manages to enter one segment and turns losses on the entire segment, Rs13-14 billion on its book would not hurt it but it would damage digital banks.
“Banks would come in and cut rates. For them it is too much work too much hassle and very little business which is why banks have been reluctant to enter such segments like BNPL and SME lending or female focused lending in the first place. But imagine a situation where the market has matured in say 8-10 year’s time, the banking industry has the muscle to either capture it or ruin it,” says the banker.
Allowing incumbents entry into digital banks space is being perceived as a means for incumbents to frustrate any potential competition. For the central bank, as long as financial inclusion goals are met, it doesn’t matter who does it.
The question in the minds of the fintech players is that if the existing regulations for commercial banks actually allow them to do whatever the digital banks would potentially do, why do the commercial banks need the new license.
This question was directed at Muhammad Aurangzeb, president and CEO of HBL, which aspires to get a digital bank license, at a panel organised by the central bank to create awareness of digital banks. Aurangzeb responded that traditional banks seeking a digital bank license is along the course of natural evolution for these banks, and this would apparently help greatly with financial inclusion. “Where the banks have to step up in a very very big way is in terms of the financial inclusion agenda. We need to accelerate our journeys in accessing and banking the unserved and the underserved,” he said.
“I would like to give example of my own bank. Just through brick and mortar, HBL had a client base of 12 million by 2018. By 2021, we closed with a client base of 25 million. And ofcourse it was mobile first approach, but also the [HBL] Konnect platform which was enabled by the branchless banking regulations of the SBP sort of got us there. My point is that with the branchless banking, and large merchant acquiring presence, it [the digital bank license] is a natural evolution because it is also an opportunity to move the deposit and algorithm based lending product services into digital bank model sort of right away.”
Auragnzeb further said that banks have the ability to transition the portfolio through a digital bank license with a strong balance sheet from day one. What is further enabling for commercial banks to become a digital bank as well is the ability to leverage the skillset of the parent entity especially in areas of compliance risk and finance so that the banks don’t have to worry about building the teams and structure immediately from day one.
Conventional banks also see the technology-first digital bank license as the means to capture VC investment. “For traditional banks, it is also an opportunity to partner with the new economy and bring in strategic investors with specialised skills which would generally had not been possible with the large parent entity because that’s the reality that these are not being seen as attractive destinations for the new economy VC and tech investors,” Aurangzeb commented.
These are uncharted waters for everyone. The hype of digital banks is at crescendo, and the sentiment is that if users are to be flipped to app-based banking at a mass scale, the operating model of the banks is not the right way to do it and digital banks are the way to go. However, in the presence of the aforementioned challenges, there are also doubts whether such digital transformation would be achieved if digital banks end up not being able to sustain for a duration long enough.
Alif, too, said that at this point in time they had preliminary expectations and it would need three years to say if their goals were achieved or not. Right now, for them a digital bank license is not certain because the SBP has to give away five licenses out of 20 applications received. Alif is really keen on serving the customer in Pakistan, and waiting eagerly to hear from the State Bank of Pakistan.