Price-focused strategy of Philippines digital banks not sustainable – Fitch

MANILA, Philippines — The price-focused strategy of digital banks operating in the Philippines to compete with traditional banks is not sustainable in the long run, according to Fitch Ratings.

“We believe that this pricing-focused strategy is unlikely to be sustainable in the long run, although it should support continued expansion of the digital bank segment over the next two to three years,” Fitch said in a report.

Despite the rapid growth over the last two years, Fitch said the aggregate market share of digital banks in terms of system deposits was still less than 0.4 percent at end-June this year.

The debt watcher said the relatively low average deposits per customer also suggest they have yet to capture a significant chunk of their depositors’ operating accounts.

“We expect digital banks will continue to compete aggressively for deposits over the next two years as they seek to refine their business models and build the scale necessary for sustainable operations. Most compete largely on pricing to attract new customers – given their relatively nascent franchises – but this has become more difficult in the recent higher-interest-rate environment,” it said.

Some digital challengers, Fitch said, are offering promotional deposit rates as high as 15 percent versus average time-deposit rates of about four to five percent,” Fitch said.

According to Fitch, increased digitalization has lowered barriers to account-switching, and allowed customers to move deposits relatively quickly when promotional rates run out, making it harder to retain customers for the digital banks that compete solely on pricing.

“We believe those digital banks that are backed by established corporates with complementary business lines and extensive customer bases will enjoy a competitive advantage relative to other digital peers in the longer run, and are likely to enjoy stronger growth in the near to medium term,” Fitch said.

The credit rater pointed out that high funding costs influence digital banks’ risk appetite, encouraging lending to higher-yielding, albeit higher-risk segments, such as unsecured personal, as well as small and medium enterprise (SME) loans.

“This should help the banks maintain positive credit spreads, although we expect most digital banks to continue to make a loss in the near term due to high credit costs and sustained investments as they build their franchises and expand their customer base,” it added.

According to Fitch, digital banks in the Philippines have grown rapidly since its inception less than two years ago due to the large unbanked population in the country.

However, Fitch said digital banks remain modest as a share of the total market.

“We do not believe it will shake competitive dynamics within the Philippine banking sector significantly in the medium term. We expect their impact on the ratings of Fitch-rated banks will be limited,” it said.

It explained that digital banks that are backed by established corporates with complementary business lines and extensive customer bases would enjoy a competitive advantage relative to other digital peers in the longer run, and are likely to enjoy stronger growth in the near to medium term.

Fitch said retail-loan quality in the Philippines has historically been more volatile and weaker than that for corporate loans.

“We believe digital banks will face a difficult challenge in managing their retail-loan risks in light of their focus on higher-risk segments and the underbanked population.

As of end-September, digital banks booked a non-performing loan (NPL) ratio of 8.5 percent, significantly higher than the banking system average of 3.5 percent.