Internet-only banks could potentially serve a credit-strapped young demographic that prefers to bank online, but what will be the effect on an already saturated banking sector?

Taiwan is overbanked. Its 37 banking institutions operate roughly 5,000 branches for a population of about 23 million people. Because the sector’s US$1.6 trillion in assets are spread among so many different banks, no individual institution is big enough to compete regionally with global heavyweights.

Given the surplus of banks here, it may seem surprising that the government has been encouraging new market entrants, but there’s a reason for it. Taiwan’s traditional lenders aren’t necessarily able to meet the needs of young entrepreneurs and consumers, both of whom struggle to access credit and prefer to do their banking digitally. Virtual banks could fill that void from digital-first platforms tailored for users in their 20s and 30s. They could offer everything from micro-lending to artificial intelligence-powered wealth-management services.

The Financial Supervisory Commission (FSC) plans to issue the first two virtual-banking licenses in June. The FSC decided to issue just two licenses in the first round of approvals to mitigate the effects of the new market entrants’ arrival on the already saturated banking market, Commission Chairman Wellington Koo said at a news conference last year. He added that the exit of two banks from the market in recent years opened up two slots for virtual banks. China Development Financial Holding Corp. acquired Cosmos Bank in 2014 and Yuanta Financial Holding Corp. purchased Ta Chong Bank in 2016.

The first two licenses will serve as a trial to create new financial services platforms for Taiwan, says attorney Jaclyn Tsai, chair of the Taiwan Fintech Association and a former minister without portfolio.

Since the banks will be virtual – and in need of digital expertise – the FSC is permitting tech firms to take up to a 50% stake in them. The other half will be held by either a traditional bank or financial holding company.

“Taiwan needs a relatively safe way to provide digital financial services that allows the traditional banks to participate,” says Hank Huang, president of the Taiwan Academy of Banking and Finance (TABF), a think tank and training center for finance professionals.

The presence of traditional lenders as shareholders in the virtual banks could mitigate real risks as well as the perception of risk, Huang says. “Would you want to put all of your money in an internet-only bank?” he asks. “Some young people might, but a lot of other people would hesitate – unless a traditional bank that they trust were involved.”

Still, the internet banks’ business model will differ from that of traditional banks, analysts say. “They do not intend to operate the online-only businesses from a traditional bank perspective,” says Lee Cheng-hwa, a senior industry analyst at the Market Intelligence & Consulting Institute (MIC), a semi-governmental research house. “Instead, they aim to leverage large amounts of consumer data to precisely target different market segments with digitally based products.”

License to bank

Three consortiums have applied for the first virtual-banking licenses. A group led by Chunghwa Telecom (with a 41.9% stake) and Mega Financial Holding (25.1%) has applied to set up Next Bank, which would offer deposit and lending services, insurance policies, and wealth-management services. Japanese e-commerce giant Rakuten (51%) and Taiwan’s Waterland Financial Holding (40%) are leading a second group. The third consortium is headed by Line Financial, the financial-services arm of Japan’s Line messaging app, which has applied to hold a 49.9% stake in Line Bank. Four banks – Standard Chartered, Fubon, CTBC, and Union Bank – would take a joint 40.1% stake in the venture.

Among the three groups, Line Bank has been lobbying especially vigorously to win the license. At a November 2018 press conference, Line Taiwan’s general manager, Roger Chen, said that the company supports the FSC’s goal of using digital banking to boost financial inclusion. The company’s large user base, which includes 21 million accounts in Taiwan, would help it provide financial services to more people, Chen said.

At a March press conference, Line Bank’s chief executive officer, Morris Huang, noted that traditional lenders are reluctant to extend loans to young people, who have yet to build a strong credit score. Huang said that Line Bank planned to develop its own method for evaluating the credit of users.

“It is a sore point for young consumers, so we will take the initiative by inviting them to use our model,” Huang told the media.

Line Bank also plans to offer wealth-management services powered by robo-advisers. The virtual financial consultants use algorithms to provide simple portfolio management solutions for individual investors. The service is popular among millennials for its ease of use and lower cost compared to traditional wealth-management advisors.

In applying for a virtual bank license, Line Bank has many strengths working in its favor, says MIC’s Lee. They include “a strong shareholder structure” given the participation of the four banks, as well as a large user base thanks to the popularity with Taiwanese of its messaging app. In addition, “Line has already tested the waters in the financial sector” through Line Pay, which is Taiwan’s top mobile payments app, Lee says.

For its part, the Rakuten-Waterland group can draw on the Japanese company’s deep pockets and experience in internet finance, Lee says. For instance, Rakuten has a US$100 million fintech fund that leverages the company’s expertise in card and payments services, banking, insurance, securities, and asset management.

The Chunghwa Telecom group, meanwhile, is following a tried-and-true path of integrating telecommunications with financial services, Lee says. He notes that companies in Europe, South Korea, and India have all been successful with this business model.

Not an easy sell

Despite the apparent demand in Taiwan for internet banks, the newcomers will face some significant challenges, experts say. For instance, the virtual banks will have to differentiate themselves clearly in a market that already offers a large variety of financial services from different providers.

“Most Taiwanese banks already provide a significant number of web-based services,” says TABF’s Huang. “What new services can virtual banks provide?”

In fact, none of the web-only banks has proposed anything not already available in Taiwan. For people seeking small loans via an efficient online process, Taiwan has online peer-to-peer lenders like Lend & Borrow. As of mid-2018, Lend & Borrow had extended more than NT$5 billion in loans, according to Business Next. The company doesn’t need a banking license because it is engaged in private lending.

Still, Lend & Borrow says that its loan application process is even stricter than the banks. Web-only banks could find a niche market among small and medium enterprises and individuals whose profiles seem too risky for the banks or P2P lenders.

Whether they succeed will depend in part on whether the FSC lets them use less stringent criteria for evaluating borrower risk. Line Bank has said that its model will calculate an applicant’s creditworthiness differently from the standard process used by the Joint Credit Information Center, which is based on an applicant’s payment and borrowing record. Banks typically refer to the JCIC’s rating when deciding whether to issue a credit card or loan to a customer.

Line Bank has not explained quite how its evaluation process will differ from the JCIC’s.

Carl Wegner, head of Asia business development for U.S. blockchain firm R3, says that virtual banks can provide useful digital financial services, but may have trouble competing in a market as saturated as Taiwan’s. He describes Taiwan as “one of the toughest banking markets in the world.”

On the other hand, if the new virtual banks are highly successful, the resulting pressure on traditional banking could prove disruptive. Indeed, given the large number of people employed in retail banking in Taiwan – many observers say there is overemployment – significant job losses could occur if virtual banks take business away from traditional lenders.

Prior to adopting many web-only banks, Taiwan should consider pushing to consolidate the banking sector, Wegner says. “Most other markets in Asia have already consolidated their banking sectors,” he says. “It’s helpful from the standpoint of building banks with scale and improving the competitiveness of individual banks.”

Kuomintang legislator Jason Hsu, a key fintech proponent among Taiwanese politicians, also regards consolidation as a priority. “Virtual banks that offer the same services I can access from my existing bank on my smartphone don’t offer a compelling value proposition, especially given how overbanked Taiwan already is,” he says.

Rather than issue full banking licenses to internet banks, the FSC should issue limited licenses that allow fintech startups to offer select services to consumers and businesses, Hsu says. He adds the caveat that the financial regulators appear squeamish about allowing technology firms to play a major role in Taiwan’s banking sector. “They’re really hesitant to let tech into finance,” he says.

TABF’s Huang acknowledges that requiring virtual banks to partner with traditional banks could ultimately restrict the scope of the web-based banks’ business. “Taiwan wants to be creative in banking – but it doesn’t want to take any real chances,” he concludes.