Unlocking financial inclusion

IF digital banks are the answer, what is the problem? The Philippines has long struggled with financial inclusion with over 70 percent of its population remaining unbanked as of 2019. Traditional banks have focused heavily on commercial lending, leaving a rapidly growing and digitally savvy population with limited access to the financial services they need. This gap in financial access has been a major obstacle to economic development and prosperity in the country.The rise of digital banks in the PhilippinesRecognizing the urgent need to address this problem, the Bangko Sentral ng Pilipinas (BSP), the country's central bank, has taken a bold step in 2020 by introducing a new formal category of banks — digital banks. These digital banks are envisioned as a solution to the Philippines' financial inclusion challenges, leveraging technology to reach underserved segments of the population and provide them with convenient, accessible and affordable banking services.Tonik, Overseas Filipino Bank and UnionDigital Bank of UnionBank Corp. are the pioneering digital banks to launch in the Philippines. Since then, several more digital banks have been approved by the BSP, including Maya Bank, GoTyme Bank and Unobank. However, in 2021, the BSP has announced that it would stop approving the establishment of further digital banks for 3 years in order to strengthen the industry and ensure healthy competition among its players.The challenges facing digital banksWhile the introduction of digital banks in the Philippines has been a significant step toward improving financial inclusion, the journey has not been without its challenges. According to the BSP, only two out of the six digital banks operating in the country are currently profitable with the rest still struggling to find the right business model and target market.One of the primary challenges facing digital banks is the higher incidence of nonperforming loans within their portfolios. In 2023, the BSP has reported that 14.49 percent of the total credit portfolio of digital banks was classified as nonperforming, a figure notably higher than the 3.24 percent bad loan ratio observed across the broader Philippine banking sector. This high level of nonperforming loans has forced digital banks to allocate a considerable portion of their capital toward provisions for losses, constraining their ability to extend new credit and contributing to increased operational expenses.Another obstacle is the limited information infrastructure in the Philippines. The narrow coverage of the national ID system complicates know-your-customer compliance while the nascent credit bureau database offers only a limited assessment of prospective borrowers' creditworthiness. Additionally, the underdevelopment of traditional financial systems, such as low rates of point-of-sale penetration and credit card uptake, presents additional challenges for digital banks.Fulfilling the promise of financial inclusionDespite these challenges, digital banks in the Philippines have made significant strides in attracting customers and driving financial inclusion. The six digital banks collectively have opened approximately 8.7 million deposit accounts, representing around 7 percent of all bank deposit accounts in the country. This indicates a growing interest in digital banking services among the population.Moreover, digital banks have been able to leverage technology to reach underserved segments of the population such as the unbanked and underbanked. For example, Maya Bank, a digital bank powered by PayMaya, has targeted the unbanked by offering its app in multiple languages and providing access to financial services through its extensive network of partner merchants and agents. GoTyme Bank, on the other hand, provides a "phygital" experience, seamlessly integrating digital and physical customer interactions in order that customers can conveniently open an account within 5 minutes using the app or at kiosks, located in Robinsons malls, where bank ambassadors offer support.The BSP's efforts to create a supportive regulatory environment for digital banks have also been crucial in enabling these institutions to fulfill their promise of financial inclusion. The introduction of new digital banking licenses, the creation of a real time payments system and the establishment of a standardized quick-response or QR network have all contributed to the growth and development of the digital banking sector in the Philippines.Prospects for the futureLooking ahead, the future of digital banks in the Philippines appears promising but not without its challenges. The BSP has recognized the need to carefully monitor the performance and impact of these new entities on the financial system, which has led to the imposition of a 3-year moratorium on new digital banking licenses.The upcoming industry report from the BSP is expected to provide valuable insights and recommendations on the regulatory framework for digital banking in the Philippines. This report is expected to influence decisions regarding whether to lift, partially lift or extend the moratorium — with considerable implications for the future direction of the digital banking sector.One potential path forward for digital banks in the Philippines is to focus on niche markets and underserved segments of the population. By tailoring their products and services to the specific needs of these target groups, digital banks may be able to establish strong market positions and achieve profitability more quickly.Another strategy could be for digital banks to explore partnerships and acquisitions as a means of accessing the Philippine market. The BSP has indicated that the simplest way for a foreign player to enter the market may be to acquire a small rural bank and repurpose it for digital banking as Seabank Philippines has done.Regardless of the specific strategies employed, it is clear that digital banks in the Philippines have a crucial role to play in addressing the country's long-standing financial inclusion challenges. By leveraging technology to provide accessible, affordable and convenient banking services to the unbanked and underbanked, these institutions have the potential to drive economic growth, empower individuals and create a more inclusive financial ecosystem in the Philippines.Reynaldo Lugtu Jr. is the founder, chief executive officer and chief technology officer of Hungry Workhorse, a digital, culture and customer experience transformation consulting firm. He is a fellow at the United States-based Institute for Digital Transformation. He teaches strategic management and digital transformation in the Master of Business Administration Program of De La Salle University. The author may be emailed at rey.lugtu@hungryworkhorse.com