WhiteSight

Cracking the profitability code of successful digital banks

Table of Contents

The rise of digital banks has been one of the most significant trends in the financial services industry in recent years. While many digital banks have gained a significant following among digital-savvy consumers, the truth is that profitability remains elusive for most of them. In fact, only a handful of digital banks have been able to register profitability.

In today’s environment, profitability is paramount for the continued survival of digital banks. High inflation and interest rates affect the cost of capital and credit, making it challenging for digital banks to operate with low margins. Secondly, venture capital funding for digital banks has decreased, making it challenging for them to sustain growth without generating consistent profits. Finally, regulatory scrutiny on the profitability of digital banks is increasing, with authorities requiring them to demonstrate a sustainable business model.

This blog will explore the various factors that contribute to the profitability of digital banks, such as lending, technology monetisation, SME banking, customer base monetisation, and marketplaces, and how they can help digital banks achieve their growth goals.

Disclaimer:
The scope of this study is limited to digital banks that operate and report their financials as standalone entities, even when they are owned by financial or non-financial organisations. For the purposes of this study, we have excluded diversified digital banks which were established as part of a larger fintech company’s diversification strategy, such as Wise, Robinhood, and Block (CashApp), among others. Additionally, embedded digital banks, which are financial services offered by non-financial companies such as e-commerce, technology, or ride-hailing firms like Uber Money, Grab Finance and Apple Savings etc., have also been excluded from this study. Our blog on digital banking taxonomy explains these nuances better.

Profitability is a subjective concept in accounting terms – while the most obvious guess is the bottom line or net profit (after tax) of a company, sometimes companies also allude achieving net profits at the operating levels (operating profit or positive EBITDA or profit before tax) to have reached profitability. So do take all of these proclamations of profitability with your own pinch of salt.

Profitable digital banks: Global success stories 

Disclaimer: If you are aware of any profitable digital banks that have been inadvertently excluded from our report, we apologise for the oversight. We encourage such institutions to reach out to us (hello@whitesight.net), as we would be delighted to update our research and revise the content of this blog accordingly.

Asia Pacific

Out of the 26 profitable digital banks, around 60% (15) are located in China, Japan, South Korea, and Indonesia. Their success can be mainly attributed to the presence of strategic shareholders – large tech companies with robust digital capabilities and an extensive customer base. While China, Japan, and South Korea have had a well-established digital banking ecosystem for several years, Indonesia’s digital banking sector experienced significant growth in 2022. This growth was primarily due to the participation of platform companies such as Alibaba-backed Akulaku, Gojek, Grab, and Sea Group, acquiring incumbent banks and transforming them into digital banks – specifically Bank Jago, Seabank Indonesia, and Bank Neo Commerce

Niche-licenced banks called payment banks in India, such as Paytm Payments Bank and Fino Payments Bank, are also profitable owing to their ability to establish a diversified set of revenue streams of transaction fees, cross-selling of financial products, and merchant partnerships.

Note: Payments banks in India are regulated by the RBI and are allowed to take deposits and provide basic banking services, but they cannot offer loans or credit cards. Although they share similarities with digital banks, such as their digital-first approach, they are considered a different entity and operate under different regulatory frameworks with specific regulations.

The UK and Europe

Starling Bank, OakNorth Bank, and Zopa are three examples of profitable digital banks in the UK and Europe that specialise in offering credit services. Starling Bank has been offering both consumer and business loans for several years and has recently expanded into the mortgage business through its acquisition of Fleet Mortgages in 2021 and the loan portfolio of specialist lender Masthaven in 2022.

OakNorth Bank is a digital bank that focuses on providing loans to small and medium-sized businesses, using a data-driven approach to assess creditworthiness. Zopa, which acquired a full banking licence in 2020, is a peer-to-peer lending platform that connects lenders with borrowers for credit products. Recently, Revolut and bunq have also announced that they have become profitable. Revolut, which has only recently started offering credit products in the Europe, went about achieving profitability through its financial super-app strategy and value-added service subscription plans.

Rest of the world (US, Brazil, Russia)

With 70 million customers in Brazil and 75 million customers worldwide, Nubank has adopted a credit-centric approach for digital banking. Nubank generates income not only from traditional banking fees such as credit card transactions and account maintenance fees, but also from credit products, insurance, crypto, and loyalty programs. This diversified revenue model has helped Nubank to sustain profitability and attract a large customer base. Tinkoff Bank is a leading digital bank in Russia and one of the most profitable digital banks globally. It offers a range of personal and business banking services, including credit cards, loans, insurance, and investments.

Following its acquisition of Radius Bank in 2021, LendingClub, previously a P2P lender, has been profitable due to a change in its business model. The acquisition allowed LendingClub to retain a larger share of interest income from the loans it originated, leading to improved profitability.

The key factors behind the profitability of digital banks

When it comes to digital banking, profitability is a key metric that can make or break a company. However, the time it takes for digital banks to become profitable can vary widely depending on a range of factors, including ownership structure and regulatory environment.

Our analysis shows that the average time to become profitable for digital banks owned by consortia in Asia is lower than independent digital banks in the UK/Europe. We will examine how consortium-owned digital banks can leverage the resources, expertise, and networks of their parent companies, as well as the regulatory and competitive landscape.

The role of ownership

The profitability of Asian digital banks highlights the significance of ownership as a crucial factor in the puzzle of profitability.

The ownership of digital banks in China, Japan, South Korea, and Indonesia by tech companies and conglomerates has helped them become profitable in several ways:

  1. Access to established customer base: Tech companies and conglomerates often have an established customer base, which can help digital banks to acquire customers more quickly and efficiently. This can help reduce customer acquisition costs.
  2. Leveraging technology: Access to cutting-edge technology and expertise can help digital banks to develop and deploy their products and services more quickly and efficiently. This can help to reduce costs and increase operational efficiency.
  3. Cross-selling opportunities: Tech companies and conglomerates often have a broad range of products and services that can be cross-sold to digital banks’ customers. This can help to increase the average revenue per customer.
  4. Brand recognition: The strong brand recognition enjoyed by these companies can help digital banks to establish their brand more quickly and effectively. This can help to increase customer trust and loyalty.
  5. Ability to procure banking licence: The significant resources available to the parent company have made it easier for them to apply for and obtain banking licences. This has unlocked several benefits, such as access to cheaper capital and interbank payment rails.

Digital banks in Asia are killing it with their consortia business model! Unlike the greenfield approach we see in the UK, Europe and the US, successful banks like WeBank and MYBank in China are led by powerhouse companies like Tencent and Alibaba’s Ant Financial. The Indonesian digital banking sector is also becoming an extended battleground for Tencent and Alibaba, where GoTo (backed by Tencent) and Akulaku (backed by Ant Financial) have acquired significant ownership in Bank Jago and Bank Neo Commerce. These new owners have also facilitated a swift transformation of Bank Jago and Bank Neo Commerce into digital-first banks. And get this, it’s not just China – regulators across several Asian countries, including Hong Kong, Taiwan, Malaysia, Singapore, and South Korea, are giving out digital banking licences left and right to consortia.

The importance of SME banking

Small and medium-sized enterprises (SMEs) represent a significant and underserved market segment for digital banks. Digital banks can leverage this whitespace opportunity by offering tailored banking services to these businesses in the form of instant bank accounts, simplified lending processes, flexible credit options, digital invoicing and payment solutions, and accounting and bookkeeping services.

Several profitable digital banks, such as OakNorth, Redwood Bank, Judo Bank, Starling Bank, Tinkoff, and Webank, have focused on the SME segment as a part of their business growth strategy. While others like Revolut, bunq, and Nubank have launched new products and services that cater to the needs of SMEs. Revolut has launched a business account that allows SMEs to manage their finances, send and receive payments, and access a range of other financial tools, such as expense management solutions and payment terminals. Similarly, bunq has introduced a range of business banking products that include invoicing, payment requests, and international transfers, among other features. Nubank, on the other hand, has launched a range of credit products, such as overdrafts and loans, that are tailored to the needs of SMEs.

The crucial role of lending

Digital banks can capitalise on the lending, which remains the primary revenue source for traditional banks, by targeting monetisation strategies towards their substantial customer base. Banks with their own full banking licence have an added advantage due to a lower cost of capital, thanks to surplus customer deposits.

Credit-focused digital banks like Nubank, Tinkoff, Webank, Kakaobank, Judo Bank, Zopa, and Lending Club have successfully leveraged lending to drive their growth and profitability.

Nubank, for instance, offers consumer and business loans, while Tinkoff has a strong focus on credit cards and personal loans. Webank in China has a wide range of lending products including mortgages, personal loans, and auto loans. Kakaobank in Korea provides various lending products and services such as overdrafts, loans for small businesses, and home mortgages. Judo Bank in Australia provides lending to SMEs. Zopa in the UK and Lending Club in the US are both P2P lending platforms transformed into digital banks and offer personal loans and business loans.

Starling Bank and bunq have acquired Fleet Mortgages and Capitalflow, respectively, in order to concentrate on the mortgage lending and SME lending business.

Technology monetisation through BaaS

Technology monetisation through banking-as-a-service (BaaS) is becoming increasingly crucial for the profitability of digital banks. OakNorth Bank and Starling Bank are two examples of digital banks that have successfully leveraged their technology capabilities to offer BaaS solutions to other banks and financial institutions.

Starling Bank has partnered with Standard Chartered to offer digital banking services under the “Shoal” brand, while OakNorth has partnered with various banks in the US, such as Capital One, Fifth Third Bank PNC Bank, and SMBC Bank to power their commercial lending business. Similarly, Webank in China, has leveraged its technology platform to offer BaaS solutions to other financial institutions in the country to modernise their technology stack.

Non-traditional revenue streams

Premium subscriptions, crypto services, and marketplace offerings have become increasingly important for the profitability of digital banks.

bunq, a digital bank based in the Netherlands, offers a variety of banking services to its customers. One of the primary ways that bunq generates revenue is through its subscription plans, which offer different levels of features and benefits such as access to higher interest rates, cashback on purchases, travel insurance, and access to airport lounges.

Revolut offers a range of cryptocurrency services, allowing customers to buy, sell and hold cryptocurrencies. Nubank has recently launched a rewards program that allows customers to earn points for using their credit cards.

Additionally, digital banks such as Starling and Nubank are increasingly offering marketplaces where customers can access a range of third-party financial services such as investments and insurance, which helps generate additional revenue streams.

The pursuit of profitability

The pursuit of profitability is a critical factor for the survival and long-term success of digital banks. Successful and profitable digital banks have a differentiated customer value proposition, focus on revenue-generating products early on, have quick scalability, and operate with cost efficiency. As the digital banking industry continues to grow and evolve, with the participation of brands and digital platforms with embedded banking propositions, cracking the profitability code will emerge as a critical challenge for these challenger banks.

Authors

Founder & CEO | sanjeev@whitesight.net

Sanjeev is a fintech aficionado who loves to explore the depths of the industry as much as he loves to explore the depths of the ocean in his scuba gear. He is the founder and CEO at WhiteSight, bringing a wealth of research and advisory experience to the fintech world.

Fintech Analyst

Samridhi is a fintech analyst within the WhiteSight team, researching fintech trends and providing insights into everything from new markets and investment opportunities. Just like she connects the dots to reveal the big picture of the ever-evolving fintech landscape, she has a keen eye for discovering the brushstrokes of Madhubani paintings and the contours of the hills.

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