In case you missed it, a great battle has been underway in Pakistan’s banking sector for nearly three years now. It started in March 2022, when the State Bank of Pakistan (SBP) announced it had created a digital banking framework.
The announcement had the entire banking sector on its toes. This was a chance to be an early mover in the future of banking. Everything about digital payments and EMIs in Pakistan had shown commercial banks that digital was the way to go in the future. And what is the harm if you can have a full-fledged bank without incurring the massive capital cost of opening branches?
Everyone scrambled to put together propositions to the central bank. They received as many as 20 applications from leading banks such as HBL, UBL, Alfalah and JS, microfinance banks, domestic fintech companies, foreign fintech companies and large business groups that formed a consortium with partners that know banking.
From this initial glut of applicants, the SBP began a weeding process. It took them nine months, but in January 2023 they whittled this down to five candidates. The state bank granted NOCs to five institutions — namely Easypaisa, Hugo Bank, KT Bank, Mashreq Bank, and Raqami Bank — to set up digital banks. It would take another nine months, but in September 2023, these institutions were subsequently granted in-principle approval. Up until this place the chosen-five were neck and neck.
Now, nearly two whole years after the shortlisting, a frontrunner has emerged. Mashreq Bank has been granted the first restricted license to begin pilot operations in the country this past week. This means that within an enclosed group of people, the bank can begin its operations with the SBP closely observing how it goes.
Mashreq Bank has always been a strong contender. While it is not a name as recognisable as Easypaisa, probably the most household name in the entire list, it has some strong backing. It is one of the largest conventional banks in the Middle East and also has a brick-and-mortar presence in Pakistan. Mashreq Bank’s digital bank offerings in the Middle East include specialised banking solutions for startups and SMEs, and calls itself the “Best Digital Bank” in the MiddleEast.
Digital Banks require some serious investment as well. While the initial capital requirement may be $25 million, to run a successful operation it will stretch to much more. According to some estimates, it could go as high as ten-times that figure.
Mashreq Bank is the oldest private bank in the MiddleEast, having been founded in 1967. Its founder, Abdul Aziz Ghurair, sits on a multibillion dollar fortune according to Forbes and the bank is majority owned by the Ghurair family – one of the richest families in the MiddleEast – through two different investment firms. They also have the technological experience, being the first to make a digital only bank for retail called NeoBiz.
All of these are signs for why Mashreq Bank could be the real deal in the digital banking space. But being first does not always guarantee you will win. There are other strong contenders still hoping to break through, and even if the competition is far, the terrain of Digital Pakistan is not the easiest to traverse, especially when you are first on the scene. After all, you do not want to become an example others learn from.
Regulatory Framework for Digital Retail Banks in Pakistan
The SBP’s regulatory framework for Digital Banks was introduced in January 2022 and established two distinct categories: Digital Retail Banks (DRBs) and Digital Full Banks (DFBs). While DFBs can serve all customer segments, DRBs primarily focus on retail customers. Though DRBs may offer services like e-wallets and digital payment accounts to corporate or commercial segments, these accounts must not exceed 40% of total deposits, excluding P2G, G2P, and utility payments. DRBs must maintain stringent capital requirements, including a minimum Capital Adequacy Ratio of 15%, comprising 9.5% CET1 CAR, 12.5% total CAR, and a 2.5% Capital Conservation Buffer.
Within this framework, the central bank also laid out a structured path for what to do if an entity wants to establish itself as a digital bank. It starts off pre-application consultations with the SBP. Applicants must submit comprehensive documentation, including a feasibility study and business plan, along with a Rs 10 lakh processing fee. They must demonstrate their financial capacity to meet capital and liquidity requirements. Success at this stage leads to a No Objection Certificate from the SBP, allowing incorporation as a public limited company with the SECP.
Following incorporation, you enter a 12-month In-Principle Approval phase. Upon achieving operational readiness, a restricted license for pilot operations lasting three to nine months is granted. During this pilot phase, operations are limited to select groups such as sponsors, employees, and their relatives. With an initial Minimum Capital Requirement (MCR) of Rs 1.5 billion, deposits are capped at 25% of MCR with individual limits of Rs 5 lakh, while lending cannot exceed 50% of the deposit base. This controlled environment allows for thorough testing of systems, products, and customer engagement protocols.
The final stage begins with commercial launch, initiating a three-year transition phase. The MCR increases to Rs 2 billion initially, rising to Rs 4 billion by the third year. This phase implements progressive caps on deposits and lending to ensure controlled growth. Deposit limits start at six times MCR, expanding to twelve times by the third year, while the Advances to Deposit Ratio (ADR) gradually increases from 50% to 70%. Consumer finance remains restricted to 40% of total advances throughout. Upon completing the transition phase, deposit limits are removed and ADR increases to 80%, though the consumer finance cap persists at 40%.
Why do we need Digital Retail Banks?
Digital retail banks like Mashreq Bank represent a fundamental shift in banking, offering streamlined services that traditional banks cannot match. The key differentiator is end-to-end digitalization: from online KYC verification to instant loan decisions based on automated credit scoring that considers income, credit history, and digital footprint. This eliminates weeks of manual processing typical in conventional banking.
The digital advantage extends beyond basic services. While Electronic Money Institutions (EMIs) excel in payments and transfers, digital retail banks offer a comprehensive suite of financial products including investments, lending, and insurance. Their platforms typically provide superior user experience compared to traditional banks’ often problematic mobile apps.
Both Mashreq Bank and Easypaisa enter this space with significant advantages. Mashreq leverages its existing back-office operations in Pakistan, while Easypaisa builds on its extensive branchless banking network, giving them solid foundations for digital banking operations.
According to banking experts, these digital banks primarily target urban millennials and Gen Z, though their services extend to older generations with larger deposits. Millennials, with established credit histories and stronger earning potential, are immediate prospects for credit products. Gen Z, while currently focused on basic transactions, represents future growth potential. SMEs and corporate clients will receive limited services initially, with rural expansion planned for later stages.
However, the path to digital banking success in Pakistan isn’t straightforward. The prevalence of traditional bank branches across the nation underscores a crucial reality: establishing a viable digital retail bank in Pakistan’s unique market conditions presents significant challenges beyond the apparent technological advantages.
The arduous journey ahead for Mashreq Bank
Digital retail banks face several challenges that could impact their ability to grow and operate efficiently in a highly competitive and rapidly evolving financial landscape.
The primary obstacle for Mashreq Bank, like any other digital bank operating in Pakistan, will be raising deposits. Unlike traditional banks, which benefit from physical branches where customers can directly deposit cash, digital banks like Mashreq Bank rely on digital channels to gather funds.
This presents a challenge in attracting customers to deposit money, as many consumers are still accustomed to the traditional brick-and-mortar experience. Furthermore, they also lack the extensive physical infrastructure and personal relationships that help traditional banks maintain high levels of deposits. Thus, Mashreq Bank may struggle to convince customers, particularly former generations with enormous deposits, to entrust them with their funds due to the absence of trustworthy relationships. As they say, “the more hands you shake, the more money you make.”
Another significant challenge for Mashreq Bank is managing liquidity, particularly regarding where customers can deposit and withdraw money. Since it will primarily operate through online platforms, it will face limitations in offering easy access to physical cash and facilitating cheques. The convenience of accessing cash and using cheques with digital banks may not be as immediate or widespread as with traditional banks that have an extensive network of branches and ATMs. Furthermore, it must maintain adequate liquidity to meet withdrawal demands while optimizing its investments. This balance is critical for maintaining financial stability and trust among customers who expect quick and seamless access to their funds at all times.
While the above two might seem like daunting tasks, another pressing concern for Mashreq Bank is cybersecurity, the foundation on which its existence depends. As a digital-first institution, it is vulnerable to a range of cyber threats, including cyberattacks, phishing schemes, and data breaches. These threats not only jeopardize the security of customers’ personal and financial information but also damage the reputation of the bank. Moreover, digital financial literacy remains restricted in Pakistan, which poses a significant challenge, particularly as the adoption of digital banking grows. Many customers are unfamiliar with secure online banking practices, making them more vulnerable to online scams, fraud, and unauthorized transactions. The gap in awareness about managing passwords, recognizing legitimate communications from banks, and avoiding cyber threats often leads to security breaches. This limited understanding hinders trust in digital platforms, slowing the transition from traditional to digital banking.
While digital retail banks such as Mashreq Bank offer innovative services and convenience, they must navigate significant challenges related to raising deposits, liquidity management, and cybersecurity. The effective resolution of these issues is essential for their progress in the modern financial ecosystem.
How they could make it work
Mashreq Bank, in order to amass gigantic sums of deposits might offer enticing financial incentives to customers such as higher savings yields, lower credit card rates, and innovative reward programs such as cashback, travel perks, or exclusive benefits. These offerings will not fill their treasuries with funds but encourage customer engagement and drive long-term loyalty. Moreover, it could introduce tiered benefits based on account activity or balances, which can further incentivize customers to deposit and maintain higher funds with the bank. These schemes will not only enable them to appeal to a broader audience but also persuade millennials and Gen Z to prefer them over traditional banks.
As far as high-net-worth individuals (HNWIs) are concerned who like to do things the customary way, Mashreq Bank might opt for personalized services, such as virtual relationship managers for them. These virtual assistants can offer tailored financial advice, assist with complex transactions, and provide a human touch in the digital banking experience. Mashreq Bank might attract and retain a key segment like HNWIs through this initiative of virtual assistants, where a human is ready throughout the day to help them with alacrity.
Another effective method for Mashreq Bank to overcome its operational challenges could be forging partnerships with conventional banks. Traditional banks can provide their APIs to Mashreq Bank, which will enable it to access customer data, allowing it to evaluate the creditworthiness of an applicant more accurately and extend loans more effectively. Additionally, it can leverage conventional banks’ ATM networks for cash withdrawals and deposits, eliminating the need for establishing its own infrastructure.
On the contrary, traditional banks can generate additional revenue by extending their APIs, customer data, and ATM networks, while simultaneously getting a shot to cross-sell their financial products to young and tech savvy customers. Moreover, there is a possibility that both parties could collaborate to come up with new ingenious financial products.
Another prerequisite for Mashreq Bank must be to invest heavily in advanced cybersecurity measures, given the rising threat of cyberattacks, where features such as encryption, multi-factor authentication, and real-time threat monitoring are essential to protect customer data and assets. They should also conduct regular customer education campaigns to raise awareness about phishing scams and online safety practices among customers. This way it can empower customers to recognize and avoid cyber threats by fostering digital financial literacy among them, building their trust in digital platforms and ensuring rapid expansion of Mashreq Bank.
The evolving demands of Pakistan’s population, especially its younger generations, make a strong case for the introduction of digital banks like Mashreq. These institutions have the potential to revolutionize financial access and meet the expectations of tech-savvy consumers. However, establishing a financial entity like a digital bank, specifically in Pakistan, a country characterized by a volatile economic environment and complex regulatory challenges will definitely prove to be a strenuous task if not impossible.
