Close on the heels of the recent trial launch of “internet-only” WeBank from Tencent Holdings, Alibaba (BABA) affiliate Ant Financials is set to launch a similar internet-only MYBank in June. This article explains the concept of “internet-only” banks, how they operate, their advantages and challenges, and how such developments can impact China's economy and its population.

What are “Internet-Only” Banks?

An internet-only bank, also known as a virtual bank, cyber bank or direct bank, breaks away from the traditional model of branch and network- based banking, and offers all possible banking services remotely with the help of technology. Included among the services offered by such banks are online banking, mobile app banking, telephone banking, self-service banking kiosks and ATMs (owned or shared-basis). All the interfaces offered to customers are customer-operated, instruction-based screens/apps, or are voice-based. Authentication techniques include verification by passwords or security questions, facial recognition and even retinal scans. Actual transactions and operations occur at a central location -- usually a computer-based back office with a parallel operating call center. (For related reading, see article: The Pros And Cons Of Internet Banks.)

History of Virtual Banking Concept

This “branch-less banks” concept has been around for a while, with the UK-based first direct being the first “telephone-only” bank, launched in 1989. It was followed by similar developments – like finatiQ, which was launched as a purely internet-based banking operation in Singapore in the year 2000.

As the internet became a more integral part of the daily lives of the average person, all traditional banks complemented their branch offering with internet banking. The “pure internet” banks were unable to keep up with these developments, as traditional branch-based banks steered past them with their multi-channels, offering a better and diversified interface to the end customers. first direct continues to operate in the UK as an internet and telephone bank, while finetiQ closed its internet-only operations in June 2011.

Advantages of Internet-Only Banks

Traditional banks incur high startup costs in the process of establishing branches across multiple locations and hiring bank employees. Internet- only banks save significantly on such real-estate, salary and operational costs, which they are able to pass on as savings to the end customers by offering very low service charges, higher rates of return, or both. (See article: Online Banks: Lower Costs And Little Sacrifice.)

Other significant advantages include the ability of customers to access banking services across large geographical distances. A farmer living in a remote village may not have a bank branch in close proximity, but he can benefit from such “internet-only” banks by accessing the mobile and internet banking services offered for savings, payment transactions, e-commerce and fund transfers.  

Challenges for Internet-Only Banks

One of the primary challenges faced by such virtual banks is customer engagement. Many customers have become accustomed to the traditional banking model, and they perceive bank branches which they can physically visit and where they can talk face-to-face with official bank employees as more trustworthy. Entrusting their hard-earned money to virtual institutions is an unnerving prospect to some.

Additionally, the traditional banks are themselves offering internet, mobile and phone banking in addition to their well-established branch networks. End customers are today having multiple choices, where they can choose to take advantage of internet-only, no-frill accounts at low cost, even with the traditional banks.

Why are “internet-only” banks growing in popularity?

China’s two major businesses, Alibaba and Tencent Holdings, have recently ventured into the internet banking space. Despite the high growth rate of China's economy, the Chinese banking system still remains in government control, with the presence of private ownership being very negligible. However, it is large enterprises which are able to access the best of what this banking system has to offer, although it is the mid-, small- and micro-sized enterprises that create the majority of the job opportunities in the country. Unfortunately, this large sector of smaller firms remains outside of the beneficiary list to receive funding from the traditional financial institutions in China. So far, such small enterprises have lacked access to the easy capital funding from traditional banks, or have incurred high costs of borrowing. (For related reading, see article: Introduction to The Chinese Banking System)

As of today, Minsheng Bank is the only private bank in China, although six other private businesses have received pilot approval for starting banking operations.

The privatization of banking services in China (including those via such “internet-only” banks) is expected to pave the way for the provision of inclusive financing services across a broader and deeper economic strata of the nation. With more players in the financial space, the benefits will reach the country's large swath of eligible small business enterprises, which will have an easier access to capital, thus leading to the further acceleration of China's economic growth. (See article: China's Economic Indicators.)

Individuals will benefit from the types of services offered, as well as better deposit rates, and access to capital for entrepreneurial ventures.  

Furthermore, the entry of private players will lead to an improvement in financial services and the emergence of innovative financial solutions, because competition will force the existing government-controlled financial institutions to create new offerings and services to keep up in the race.

At the same time, however, the tight regulations imposed by the state will ensure that failures are contained. The fact that the options trading market in China is yet to take off, despite more than two years of preparation and repeated delays, is a reflection of this intensely regulated environment. (See:  A Detailed Look Into China’s Options Market.)

Do Alibaba and Tencent have an advantage?

Alibaba and Tencent are well-established brands locally and globally. Tencent’s WeBank is named after its highly popular WeChat instant messaging app widely used in China, while MYBank is a venture of Alibaba, which is China's known leader in ecommerce. The two initiatives have the following similarities: (See article: What Is Alibaba?)

  • Both have deep local penetration to a large user base through technology, apps, e-commerce and related streams.
  • Both also have mobile payment services which allow the end-users to safely store funds in their accounts.
  • Both have also demonstrated apt business savvy by selling money-market funds through their websites and mobile apps.

Building on top of this already existing user base and widespread network will compound the benefits for both these entrants in China's financial space.

The Challenges

Winning people’s trust so that they will deposit funds in these new types of banks, and make a shift from offline branches to online interfaces will be immediate challenges to address. The expectations of the young and tech-savvy population, who constitute the section of the market that will be most open to the internet-only banking concept due to their comfort with the use of technology, will be high. There is a huge potential for this  young, tech-savvy section of the population to become a significant client base for these banks, however.  

These new banks will also face the challenge of ascertaining and assessing the data-based credit worthiness of individuals (and businesses) if their loan operations will be profitable.

The Bottom Line

Backed by their technical infrastructure and expertise in online offerings, as well as a large, already well-connected user base, both WeBank and MYBank appear fully equipped to take a successful leap in the new internet-only banking sector in China. Chinese customers have been used to the state-dominated traditional banking system (and its limitations), and may emerge as loyal and engaged customers for the new initiatives if these institutions offer lower cost options and enhanced services.