Digital banking is a financial enhancement in banks that takes deposits and provides its products and services through a digital-only business model. A digital bank can be distinguished from other digital channels, pure-play digital banks, and digitized traditional banks through the following characteristics:
- A digital front-end and operations: A physical footprint is not necessary for a digital bank. Customers are not reliant on paper documents or manual processing. They also aim to enhance UI and customer experience.
- A digital-native back-end core: Digital banks have modular and configurable micro-services-based cores. They use APIs that enable innovation and delivery at rapid rates.
- Culture and structure like those of a technology company: The horizontal structure, minimum bureaucracy, and non-hierarchical environment that enables continuous development of products, systems, and channels define digital banks.
Digital banking is present all around the world. These banks offer efficiency and accessibility in their banking experiences. The business model of digital banks is fairly new and awarded with a few licenses at a time. The modernization of digital banks is marked by the adoption and acceptance of various technological developments across different geographies by regulators.
A few innovations that define a digital bank are:
- e-KYC for full digital onboarding with identification methods tailored according to the preferences of the regulators.
- e-signatures to validate different transactions remotely.
- Open banking policy to allow data sharing for better customer assessment and permits third-party transactions.
- Non-banks can also compete in and allow consumers to benefit from their services in broader and more personalized ways.
- Cloud-hosting removes the need for infrastructure scaling, access to sophisticated architecture solutions, and the need of meeting local regulators.
How do regulators perform customer identification via digital banking?
For customer identification, there are different routes. If the customer has a national digital ID, the digital signing process can be completed based on the data stored against the required ID. After signing up, login can be possible using the same national ID. Internal validation is done and the account is opened. If the customer does not have a national digital ID, other documents can be scanned to complete the verification process. The data is extracted and various checks are performed. Either an e-KYC is done or KYC is transferred between banks if both banks support it.
Types of licensing models
Digital banking regulations are appreciated by regulators. The potential benefits of customer experience, inclusion, and competition are promoted. However, it is important to not undermine the trust and financial stability of a bank to promote a free for all market. The models followed are:
Specific digital banking license:
Regulators in different jurisdictions like Malaysia, Philippines, Saudi Arabia, South Korea, Singapore, UAE, etc. have managed to create licenses that are digital-specific, and include terms related to the kind of products that are allowed, the segments the digital bank must target and what kind of physical presence is permitted. Setting up licensing frameworks takes time, but it guarantees the regulators of the appropriate oversight of digital banking activities and ensures compliance. When designed with intent, the banking license offers clear guidelines on operations and services.
Traditional banking license:
Most European countries and the United States regulate digital banks with standard banking licenses. In such scenarios, digital banks begin with an alternate license like e-payments services or e-wallets and they request services as and when they design new ones. As far as Asian countries are concerned, in India, there are no fully digital banking licenses and hence these are called payments banks.
Regulators play a critical role in shaping the context in which banks, either digital or traditional, execute their business plans.
Understanding regulatory frameworks
The most critical phase for new digital banking frameworks is the design phase. The requirements of ownership, shareholding structure, and criteria for managers determine the types of players that can enter the market. There are three elements to this –
- Eligibility – Eligibility is based on conditions concerning business plans, ownership, risk management, and exit plans.
- Permissible activities – These cover provisions for the foundational phase, management plans, customer segment targets, and sufficient access to liquidity.
- Presence – This includes the services like branches, ATM coverage, or agent networks.
Thus, digital banking has slowly become a part of the daily lives of individuals. However, the business model is relatively new. All around the world, digital banks are subject to the same regulations as traditional banks. Moreover, digital banks are evolving fast and many jurisdictions have started developing regulatory frameworks specific to digital banks.
Having a dedicated regulatory framework sets out the core structure of digital banking.
Digital banks, when properly designed and regulated, can ensure the safety of financial systems and protect the interests of the customers. Broader policy aims are also fulfilled using digital banking regulations.
