Digital Bank is a natural 'hedging' against banking risks

Digital Bank is now a reality for a country like Bangladesh because 12 applications are already submitted to Bangladesh Bank, which are currently under review. Many argue that despite the market has 60+ banks, 30+ NBFIs, 13+ MFIs , why digital bank is still strategically critical for us? This debate is further intensified when we see digital and financial literacy of our people is still below average compared to neighboring country and our cyber security capabilities are still in question. But many of us are unaware that digital banks can act as natural preventive tool because of it's inherent business model compared to traditional bank. 'Digital Bank' as opposed to traditional bank or digital banking platforms of traditional banks is different from its business model perspective. 

Traditional banks are cost-heavy business; it requires comprehensive distribution channel (branch, ATMs, call center etc), expensive infrastructure, huge people. This model promotes higher business cost , thereby higher interest rate/fees/charges on borrowers and higher repayment burden, which in turn increases the probability of default (PD). On the other hand, 'Digital Bank' does not allow 'physical branches' , neither it needs substantial physical infrastructure & maintenance. This will need limited resources/people to run the operations. 

However, Digital Bank will be tech-heavy business model. It needs cutting-edge technology to ensure smooth functioning of banking operations and client services. This will leave an opportunity to minimize cyber/tech risks through investing on 'state-of the earth cyber risk mgt model that will also cover SOC (Security Operations Center)'. As per central bank , core risks of banks are: Credit risk, ICT (information communication & technology) risk , AML (anti money laundering) risk, ALM (asset liability management) risk, FX (Forex) risk & ICC (internal control & compliance) risk. Digital Bank with it's inherent business model can neutralize many of these risks at its inception. Let me explain with some example and context: Credit risks being top risk for the bank, arises from non-repayment of loan by the borrowers. In Digital Bank scenario, lending will be in low ticket size given to those who are screened based on parameterized data and credit-score , easily manageable and integrated with payment ecosystem through 'embedded finance' which will allow disbursement of loan fund directly to the beneficiary instead of the borrower's account. 

Besides there will be built-in or bundled payment protection insurance (PPI) where insurance cost/premium can be born by clients or shared by both bank and client. Insurance as a credit risk-transfer mechanism will be very much applicable and suitable for 'digital loan program'. Lean business model helps to reduce 'pricing of loan' , that will help balance the loan -repayment failure/irregularities. Moreover, this model with limited people will reduce the chance of people-induced fraud, mistakes, misappropriation, failures etc. Technology i.e, AI and machine learning helps to identify suspicious activities/txn proactively, thereby reduce AML risk to a great extent. Besides END USE of fund can better be ensured under this model, which will help to minimize AML risk i.e. ensuring utilization of loan fund as per declared purpose. 

Digital Bank will be mostly focused on retail & SME loan which are usually short-tenured/term. This will better balance asset and liability maturity mismatch or help to manage liquidity risk in more robust manner becasue bank will have fund from depositors, which are usually floating/short -term contracted, are/will be invested on short -term basis to retail/SME clients. Digital bank with its lean operating model & active collaboration with different partners ,can manage business risk arising out of economic shock or bearish market; since business & operating cost is comparatively low and can be staggered. With that they can survive during difficult time. On the other hand, we often notice traditional banks face substantial uncertainty regarding natural disaster, political unrest, pandemic etc. But digital bank having no branch and being appbased, rather ensure smooth operation amd client service even during the worst disaster where physical operation is impossible. Yes, Technology disruption if it happens strongly then DB operation is impacted. In such scenario, they must have strong BCP strategy and plan in place. 

Our country is now with 60% people who are young; it means these people are already used to digital platforms for different utilities. Digital Bank, since it would be app-based ,can naturally attract huge population in thier client coverage which will in turn reduce survival and competition risk. The global geo-political tension is one of the critical risks for our country as well. This impacts lives, business and economy. Digital Banking eco-system can be run irrespective of geographical locations. 

The operating model helps the business to operate in case there is any political embargo, war, unrest in any/between countries since the bank does not need to have physical branches or network or location-specific offices as such , which may require physical operations or engagement to continue business. The model also allows distant operation, multiple data center, disaster recovery center etc. We are going through 5th industrial revolution with the advent of 6G, Hyper speed internet, AGI (Artificial General Insurance) and Quantum computing. 

While these will further disrupt the way we do business, Digital Bank will remain safe compared to traditional banks since DB is based on technology. The more advanced technology comes in, this bank will have higher proximity to capitalize that for its operating model. While there are many risks that traditional banks are currently facing, will be managed through the DB model going forward, this model will bring new avenue of risks. Among them cyber security is on the top. However, the investor and entrepreneurs need to investment sufficiently in managing this risk if the want DB model to sustain in the long run. 

The author is a professional in financial service industry

Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions and views of The Business Standard.