Path to profitability still fraught for digital challenger banks

By Choi Jung-kiu

There has been a remarkable transformation of the banking landscape in the last decade, as ambitious, emerging digital challenger banks (DCBs) have disrupted the traditional landscape.

DCBs are pioneering digital banks seeking to capture and grow market share through digital-only models that cater for our increasingly connected population. As one of the most digitally integrated countries in the world, South Korea is fertile ground for this evolving financial revolution.

Yet despite the impressive growth in the number of these emerging DCBs globally, profitability remains a notable challenge, with just 13 out of 249 currently assessed as profitable.

In a Boston Consulting Group (BCG) report titled "Emerging Challengers and Incumbent Operators Battle for Asia Pacific's Digital Banking Opportunity," we identify 50 DCBs vying for market share in the Asia-Pacific region, including four here in South Korea ―KakaoBank, K bank, Viva Republica and Toss. The journey of these emerging players offers some powerful lessons both for DCBs and the legacy institutions whose throne they seek to topple.

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Region's challenger ecosystem

The Asia-Pacific is home to 20 percent of global DCBs, driven largely by consortium players backed by tech giants and non-financial institutions. Yet despite this growing penetration, just 5 percent of DCBs globally have achieved break-even status. Of those 13 players, 10 are right here in Asia-Pacific. Notably, none have yet captured a market share greater than 2 percent of the total addressable market which means there is a huge upside potential remaining.

Those successful players have managed to build a sustainable advantage through an ecosystem approach using three key pillars: leveraging assets, building and scaling the bank and sustaining success.

DCBs are leveraging assets such as brand recognition, existing customer networks, and financial services experience, often through strong alliances and partnerships. Particularly, winning DCBs leverage three assets deeply: First, strong brand recognition developed through parent brands or partners, securing client trust and offering a boost in early brand reputation. Second, utilizing an ecosystem of existing users captured through established customer bases of digital platforms for an easy transition, incorporating data-driven benefits that can inform DCB offerings. And third, building on financial service delivery experience, with previous risk management and regulatory exposure, as well as valuable early transaction and credit data.

Building and scaling a successful DCB is built on three core components ― customer obsession, scalable and flexible technology and agile organization and governance. Customer obsession is realized through a compelling value proposition and product features, and strengthened through continuous market testing. Digital banks need customers to be genuinely passionate about the user-friendly products and services they deliver, echoing the holistic, end-to-end experience expected from major tech players in our modern landscape.

Scalable and flexible technology is equally important, allowing DCBs to respond to changing customer needs in this dynamic landscape. That should include six key technology layers: integration layer with standard APIs, front-end consistent engagement layer, integrated data and advanced analytics layer, operational layers, system of records (core banking) layer and security layer with secure-by-design features

Finally, agile organization and governance is critical, with DCBs empowered by independent operations and full-speed decision making. That means organization structures designed to enable cross-team collaboration, backed by an iterative working process for continuous improvement.

One highly successful South Korean digital challenger bank has leveraged these strategies to scale rapidly since its launch in 2017, reaching over 13 million customers as of 2022, with a far lower customer acquisition cost than traditional banks.

Implications for incumbents

Incumbent banks need to adapt to compete in this changing landscape, but this modernization journey is not easy. Incumbents struggle to transition away from aging IT infrastructure and embrace the agile approach fundamental to success.

Incumbent banks are presented with three potential paths to enable this journey. First, they may choose to digitalize themselves, building on an established presence and maintaining brand exclusivity. This solution requires significant resources to execute.

Another option is to launch their own DCB ― often in partnership with fintech or other tech players ― entering the market with a new brand that leverages existing reputations. This can be reliant on partners possessing relevant capabilities and resources. A final option is establishing a secondary brand with new products and capabilities. This approach must wrestle with potential gaps in capabilities augmented through secondary brands.

What's clear is that for incumbents seeking to launch their own DCB, it is imperative that they address key questions around value, structure, position and technology to guide their ambitions.

An evolving landscape

DCBs can take up to two years to build, but the rapid pace of growth means there are undoubtedly players ― both emerging and incumbent banks ― already progressing across various stages of that journey.

Infrastructure and fit-for-purpose regulation are key enablers in allowing these banks to thrive. South Korea has a powerful platform with the former, and an encouraging landscape for the latter ― but it should not be complacent. Digital banking offers a transformative financial opportunity, but one which, equally, will require legacy institutions to transform. Those who get it right could unlock a valuable opportunity in Asia-Pacific's rapidly evolving financial landscape.

The writer is a managing director and partner at Boston Consulting Group in Singapore. He has more than 30 years of professional experience across management consulting, international banking and in leading and growing digital businesses in China and Indonesia. He is a senior fellow at the National University of Singapore, teaching the Digital Transformation Leadership Program to senior executives and author of the book "The allDigitalFuture Playbook: How to Succeed in Digital Transformation and Innovation in a Complex World."