The State Bank of Pakistan (SBP) has received an overwhelming response to its new initiative seeking the establishment of digital banks. But the worry is that these banks may not succeed in meeting their primary objective of reaching out to and serving the unbanked and underserved population without consolidated, reliable data on their spending behaviour and payment history available with the private credit bureaus for developing alternative credit scoring from the payment history of borrowers from the unbaked segments of society for such common services as mobile phone bills, utilities, etc.

The central bank has received 20 applications for digital bank licenses from domestic commercial banks, microfinance banks, electronic money institutions (EMI) and fintech players. “Foreign players already operating in the digital banking space overseas have also expressed their interest to venture into the Pakistani market,” the State Bank of Pakistan said in a statement at the conclusion of the process of receiving applications at the end of last month or just three months after the launch of its “Licensing and Regulatory Framework for Digital Banks”.

The framework primarily aims at providing financial services from account opening to deposit and lending through digital means to the unserved and underserved segments of the society at an affordable cost and encourages the application of financial technology and innovation in the banking sector. In the pilot phase, the central bank intends to issue just five licenses for digital banks, which are defined as banks that offer all kinds of financial products and services primarily through digital platforms or electronic channels instead of physical branches.

The digital banking experience in countries like China, Malaysia and Singapore shows their ability to reach out to targeted populations — low-income individuals, smallholders, micro and small businesses, etc — more efficiently than conventional banks. This is important for Pakistani consumers; for example, agri and small and medium enterprise financing is hardly 10-12 per cent of private sector loans as the conventional banks neither have expertise nor appetite for such ‘risky’ lending.

The central bank and the government must think of ways to convince telcos, power and gas utilities and others to supply data to the bureaus on their customers in bulk and on a regular monthly basis

However, many believe that the utility of digital banks will be limited unless private credit bureaus are strengthened for developing alternative credit scoring from the payment history of borrowers from the unbanked segments of society for such common services.

“These banks must lend from their very inception to survive since deposits will be slow to come,” said the chief financial and digital officer (CFDO) of a bank, requesting anonymity. “Since such lending to unbanked individuals, and small businesses and smallholder farmers involves risks, the interest rate will be high initially.”

The only way, in his view, to mitigate the default risk of digital banks is to develop alternative credit scoring of their potential borrowers from data on their use of services like landline and mobile phones, electricity and gas bills, e-commerce payments and other such sources.

However, telecom firms, as well as power distribution companies and gas utilities, are reluctant to share their data with the private credit bureaus.

“The commercial banks and microfinance banks and institutions have now started sharing data on their borrowers. But the utility companies and telecom firms are not sharing data of their customers with us. Also, we do not have access to the tax data of individuals, which can also be used to develop alternate credit scores. Whenever we approach the utilities and telecoms, they tell us that they are willing to share data on their individual clients on our demand but would not provide it in bulk or regularly. Such data made available to credit bureaus in silos is useless because it does not help us develop scoring models,” an executive of a private credit bureau told this correspondent.

He was of the opinion that if digital banks were to fast-track their lending, which they must to attain the goal of financial inclusion of low-income individuals, small businesses and farmers, they will need reliable, alternative credit scores of their potential borrowers.

The unbanked customers are difficult to lend to but not impossible even if the alternative credit scores are not available. “There are other tools available for the digital banks to ascertain the spending behaviour and payment history of such customers. But the problem is that these tools are expensive and would force digital banks to charge very high-interest rates. That defeats the very purpose of the digital banks: provision of financial services to the unbanked and underserved segments of the population at affordable prices.

“Hence, the central bank and the government must think of ways to convince telcos, power and gas utilities and others to supply data to the bureaus on their customers in bulk and on a regular monthly basis just like the commercial banks and microfinance banks and institutions,” the executive stressed.

The main advantage of the branchless, digital banks over commercial banks has to be their ability to keep their costs at 10-15pc of the expenditure of their conventional rivals and keep the lending time as short as a few days. These advantages will not be available to these banks unless they have access to reliable credit scoring models depicting the spending and payment behaviours of their customers in the consolidated form in one place.

Published in Dawn, The Business and Finance Weekly, April 18th, 2022