Several virtual banks in Hong Kong that launched to serve retail customers are now trying to expand into chasing small- and medium-sized businesses, as depositors or borrowers.
But two of the eight licensed digital banks (the new regulatory nomenclature) have focused on SMEs from the beginning.
This DigFin series is looking at how these banks will survive given challenges in attracting customer deposits. But for PAObank and ANT Bank – the two entities focused on SMEs – that hasn’t been such a problem.
While they have few customer accounts, the average size of those deposits is far bigger than those of retail virtual banks. PAObank (aka Ping An OneConnect Bank) leads the pack, with its average customer account depositing more than HK$100,000 each, according to consultancy Quinlan & Associates.
Lending focus
Michael Fei, PAObank’s chief executive and executive director, says its mission is to lend to SMEs. Over time, as it builds a customer base, PAObank can add more products, such as payments or business accounting. But at this early stage, the important thing is to build that credit product, through data, iteration, and alternative tools for credit scoring.
This will mean a slow path to profitability, he says. “All virtual banks feel the pressure,” he said. “We’re all looking for where we can make money. But we have to stay focused, because that’s the one thing we can control.”
He added he thinks it will take three to five years before the bank breaks even.
Within the world of servicing SMEs, PAObank has had to drill down even further. It’s too small to be all things to all SMEs. It began four years ago by catering to trading companies. Now it is beginning to expand into servicing retail businesses and construction companies.
“We have to get good at lending to these before we broaden into new categories,” Fei said.
That involves using data more nimbly than a traditional incumbent bank. PAObank takes customer import and export data, invoices, and even Octopus payments data to get a picture of money in and money out.
Customer portfolio
Beyond addressing certain sectors, what kind of SMEs are these? After all, banks have ignored small businesses because they’re not profitable. Is PAObank reliant on unattractive customers?
Fei says one third of the portfolio consists of SMEs that have never before used a bank or borrowed from one. They have relied on fintechs or money lenders, or on friends and family. The idea is that alternative data scoring will turn many of these SMEs into bigger and more reliable customers.
The next third of the portfolio are SMEs that are unbanked but are more substantial businesses. They are looking for securitized loans, secure credit facilities, or even a mortgage (so the business owner can put their apartment up as collateral to finance the company).
The final third of PAObank’s portfolio are SMEs that have exiting bank relationships. “Our pitch is that we are fast and simple, and that we deliver value,” Fei said. “It takes up to two months to secure a new credit line from a traditional bank, but we can approve it within five days if your documentation is ready.”
Operating model
Added together, Fei says there’s no reason why incumbents could not serve these SMEs, or serve them better. The technology involved isn’t complicated. But it needs an operating model to support serving SMEs, that incumbents haven’t bothered to address.
“It’s more than just a mobile app,” Fei said. “It’s how you approve loans, settle them, and disburse the proceeds. To do this digitally, a big bank would have to change a lot of things.”
For example, credit assessment is still the essential skill for a lender. Fei started his career at HSBC 20 years ago, where his job was to wade through potential customer’s financial reports, working out how much debt they had versus their capital, and writing up 10-page reports for the approval team.
Now he’s doing the same thing but relying on real-time data provided by the customer. It’s a process that PAObank inherited from its parent, Ping An Bank in mainland China. “We use their model to generate a credit score and set credit limits, all without needing a financial statement or collateral,” he said.
Over time, the bank will amass a swathe of data that enables it to benchmark its customers, develop better pricing models, and grow a moat against competitors – should incumbent banks decide to follow.
Challenges to profitability
That’s the focus. There are plenty of challenges, Fei says.
One is old-fashioned execution. Retaining a good team is hard. When virtual banks started business, there was a lot of buzz that made people want to work for them. Now it’s more business as usual; PAObank is, well, a bank, not a tech company.
Another problem is the rise in interest rates over the past three years. While this has been beneficial to retail virtual banks, who mostly focused on payments and other transaction-type services in their first years, PAObank was from the start all about lending. It doesn’t have the deposit base to fund that business, so it has to itself borrow.
“Most of our funding is through time deposits,” Fei said, who adds the bank can’t pass that cost on to customers. “We can’t just charge SMEs another 5 percent on debt, they can’t afford it. So our net interest margin is in decline.”
As a result, PAObank will begin to add fee-based products in order to grow its deposit base more quickly. This might include payments to mainland Chinese companies or helping SMEs purchase property and casualty insurance.
Fei’s job in the coming year will be to grow new business lines while keeping PAObank centered on SME lending. It’s a difficult environment and the bank is in a race against time – it needs to build up the data and experience to become a sharper lender to achieve sustainability. Fei can’t go to PAObank’s shareholders – Lufax Group and Ping An Insurance – cap in hand. He has to go with results.
This series includes our introduction and profiles of ZA Bank, Mox Bank and WeLab Bank.
