What Do Digital Banks in the Philippines Need to Do to Become Profitable?

Digital banks in the country will continue to remain unprofitable unless they are able to improve on the kinds of loans they extend, and refine their loan collection mechanisms, according S&P Global Ratings. 

In a recent webinar on the Philippine banking system, economy, and sovereign ratings hosted by the credit ratings agency, S&P’s Director of Financial Institutional Ratings Nikita Anand said, “The high share of unsecured consumer loans and untested credit profile of the target segment is leading to significantly weaker asset quality.”

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Data from the Bangko Sentral ng Pilipinas (BSP) as of November 2023 showed   close to 65 percent of the loans of digital banks are in personal loans, followed by reverse repurchase agreements (18.5 percent), other consumer loans (16 percent), with corporate loans a mere 0.8 percent of total. In comparison, the banking sector’s total exposure to credit cards and personal loans is around nine percent, with over 74 percent in corporate loans. 

“[Digital banks are] targeting that small-ticket personal-loans market,” Anand said. “However, this is a new segment and digital banks operations are very nascent. The credit quality of this target segment is untested at the moment, the collection mechanisms of the digital banks are currently underdeveloped and that’s why they are facing some asset quality challenges.”

Digital banks also still use people or companies to collect on loans, instead of online repayment.

Due to their heavy exposure in unsecured loans, digital banks “have to set aside higher provisions [to cover loan losses], which will eat into their profits,” Anand explained.

As of end-January 2024, BSP data showed digital banks have a non-performing loan (NPL) ratio of some 21 percent, compared to the banking sector’s 3.4 percent.

Another reason for the unprofitability of local digital banks is their high operating costs as a percentage of revenues.

“[They] are just in an investment phase, and their revenue base is very narrow, because they have just started to build their loan book,” Anand said. “So their operating expenses as a percentage of revenue is very high; it’s actually over 100 percent, compared to 56 percent for the [banking] sector.”

The Philippines has only six digital banks licensed by the BSP; these are UNO Digital Bank, UnionDigital Bank, GoTyme, the Overseas Filipino Bank of state-owned Land Bank of the Philippines, Tonik Digital Bank, and Maya Bank. The BSP imposed a moratorium on granting new digital bank licenses in 2021 as it considers these to be an “experiment.” Their market share also remains limited in terms of deposits, loans, and assets compared to the banking sector.

“So over the next two, three years, we’ll get to see how they are able to scale up this business in a sustainable and profitable manner and more importantly, I think they’ll have to really improve on credit selection and collection mechanisms to achieve a sustainable asset quality, positive growth over the next two, three years,” Anand said.

Meanwhile, the S&P representative noted the rapid growth in the exposure of the banking sector to credit cards and unsecured personal loans, which is now at eight percent of total loans in 2023 versus five percent in 2019. But she asserted that these “risks are manageable because of low household leverage and stable employment conditions.”

As per BSP data, household debt in the Philippines is estimated at 10 percent of gross domestic product (GDP)—the output of the local economy—compared to 80 to 90 percent of GDP for Malaysia and Thailand, respectively, or some 56 percent for Singapore.

Meanwhile, Ivan Tan, director and lead analyst for Southeast Asia of  Financial Institutions Ratings, explained that Philippine household debt remains low as overseas Filipino remittances provide a reliable source of funds, thus “negating the need for households to borrow from the banks.”

Also, households in the lower-income groups, which are not beneficiaries of OFW remittances are not keen to borrow from banks as they are charged much higher interest rates due to the latter’s inability to ascertain their credit worthiness (i.e., they don’t pay income tax).