The State Bank of Pakistan has formulated a new Licensing and Regulatory Framework for Digital Banks which is designed to radically transform the shape and nature of Pakistan’s banking industry. The initiative is part of the government’s plan for the promotion of digital financial services, financial inclusion, and increased competitiveness and innovation by the financial industry.

The new policy envisages two types of licenses — the Digital Retail Bank (DRB) licence and the Digital Full Bank (DFB) licence. The DRB licence is a limiting option as it allows the incumbent to only service retail customer segments excluding corporate and commercial, with less than half the minimum capital requirement (MCR of Rs4 billion) compared with what is required for commercial banks and the DFB license (MCR Rs10 billion). It offers an opportunity to licence takers to focus on segments previously not catered to by the financial and banking industry.

The innovative instrument is aimed to encourage licence takers to break new ground in terms of customer segments, models and products and services. Experience in other countries demonstrates the ability of digital banks to penetrate certain segments more successfully than the traditional banks. In the UK 18–21-year-olds constitute 26% of the customer age mix, compared to 12% for traditional banks; in India it is 31% compared to 7%. Similarly, Hello Bank by BNP Paribas, Ila Bank in Bahrain and TNEX in Vietnam have penetrated non-core client segments of banks including the youth, low-income individuals and Micro Small and Medium Enterprises (MSMEs).

Banking innovation is of great significance in Pakistan given the fact that agriculture lending is 3-4%, SME financing is 6-7% and consumer loans 5-6%of overall private sector lending. A second feature is the varied pool of sponsors eligible to apply independently and/or in collaboration for the licence—local and international commercial banks, international digital financial services entities, microfinance banks (MFBs), and EMIs. This pool has been significantly expanded from what was envisioned when the draft framework was unveiled in February 2021, signaling the SBP’s openness to exploring a healthy variety of models and approaches to meet the objectives of the regulation.

It is relevant to add here that Singapore, Malaysia and Hong Kong recently awarded digital bank licences where the applicant mix was extensive including banks, platform service providers, fintechs, telecom service providers, and even an airline company and a media house. Pakistan’s digital banking framework has generated a lot of interest globally, and it is expected that more than 20 applications will be filed in this first round.

In the given framework, the emphasis is on a digital-only entity, with a requirement to phase out any branches within seven years of starting operations. This requirement will not only reduce the brick-and-mortar footprint of the financial services industry, reducing the end price for consumers, but also push incumbents to use artificial intelligence and big data analysis, and give much-needed attention to the client experience and product offerings.

According to a research report, in Pakistan the average cost of customer acquisition and servicing for digital banks is 5-15% that of traditional banks. In China, Mybank is estimated to have a per transaction cost of 0.15% of traditional banks, while WeBank’s operating cost per account is estimated at 3 RNB compared to 20-100 RNB for traditional banks. The upcoming digital-only entities in Pakistan’s banking industry are expected to yield additional benefits such as real-time updates, quicker account approval times, quick investing services and personalisation. As the digital bank cadre grows, traditional banks in Pakistan will have to catch up with the competition. This was witnessed on a significant scale in China after the entry of digital banks in 2013.

The State Bank of Pakistan issued the Branchless Banking Regulations in 2008, which have undergone several iterations, and are now supported with additional regulations, guidelines and large infrastructure undertakings such as regulations for the digital onboarding of clients and merchants, cloud policy, and the instant retail payment system infrastructure, RAAST. But the overall digital transformation of the banking industry has fallen short of expectations. Even the microfinance industry continues to rely primarily on a physical model of outreach.

To start with, only five digital bank licences will be issued. This is in line with the number of licences issued in other countries such as Singapore which has issued four licences out of 14 applications, Malaysia six against 29 applications, and Hong Kong eight. The SBP may consider expanding this number to eight in future due to the fact that there may be slippages and other related factors.

Digital banking is a good initiative but for its success a high level educational attainment is necessary. The low literacy rate in our country will thus be a drag on the progress of digital banking.