Digital banking’s business model poses several challenges to the sector’s viability in Indonesia. In the short term, digital banks incur higher costs due to higher consumer acquisition expenses and a higher cost of funds, in addition to large capital expenditures. Indonesian consumers’ preference for well-established conventional banks after the Asian Financial Crisis bank runs is partly to blame.
Though mobile phone penetration is high, the average internet broadband speed in Indonesia is behind its peers, making digital banking difficult for consumers. Digital banks also need to hire a more tech-savvy labour force — directly competing with high-paying tech companies — increasing their costs.
Indonesia’s digital banks have limited revenue streams. Indonesia’s lack of credible data to predict the creditworthiness of consumers limits the ability of digital banks to offer potentially lucrative fast credit disbursement, forcing banks to rely on channelling and fee based incomes. This results in razor-thin profit margins, weaker capital growth and higher credit risk.
But the fundamentals underlying the growth of the neo-bank sector remain solid. A large proportion of Indonesia’s population that remains unbanked and mobile phone penetration is high. Young middle- and upper-class Indonesians welcome digital banks as a ‘trendier’ way to do banking. The large informal sector could provide rich pickings for the digital banking industry.
Indonesia’s private sector is keen to take advantage of this opportunity. Some of the country’s largest conglomerates and tech companies are developing their own digital banks to establish their own digital ecosystem. Conventional banks are following suit. For them, digital banks are a way to attract young consumers and build engagement while still relying on their conventional banking arms for support.
For conglomerates and tech companies, the digital banks have become the backbone of their digital ecosystems. Using integrated data, banks can map out consumer behaviour and forecast customer demand based on their transactions. Having a digital bank under their corporate umbrella also reduces the cost of administering surplus funds for these companies.
But these digital ecosystems could also carry risks. One is that they could lead to the unequal distribution of third-party funds in the financial system. Digital banks also disburse credit into riskier consumer loans instead of lower risk working capital and investment loans. The deployment of new technologies for storing data and performing credit analysis could also reduce consumer trust in the financial system.
Various government agencies have tried to support the growth of the digital banking sector while maintaining the stability of the wider financial sector. The government’s plans to consolidate the banking industry could push smaller banks to merge or be swallowed up by larger tech ecosystems, with the goal of increasing efficiency. The government still maintains its single presence policy, though, reducing systemic risk.
Indonesia’s Financial Services Authority supported the industry by issuing Regulation 12 in 2021, which regulates elements of the digital banking industry including capital requirements and consumer data protection. Indonesia’s central bank, Bank Indonesia, is keen to rapidly digitise the economy and improve monetary policy transmission. The bank is now studying issuing a digital currency, the Digital Rupiah.
But these moves are likely to not be enough. The government needs to increase coordination between agencies to unlock the huge potential of the unbanked population.
One possible approach is to provide the private sector with more high-frequency data. High-frequency data held by state-owned enterprises, such as mobile usage and electricity consumption data, could improve the accuracy of neo-banks’ credit disbursement models.
The government should also push through the single identity number policy to improve its Dukcapil population database. Recent integration of the tax identification number and the national citizenship number serve as a good example of how this integration could be beneficial. Benefits could include increasing the efficiency of government disaster aid disbursement, increasing the accuracy of national statistics and allowing businesses to reduce administrative costs.
To reduce digital banks’ high costs, the government and the private sector should coordinate in disseminating information about digital banks for the unbanked. Better consumer data protection laws and enforcement would also support consumer trust and further reduce costs over time.
Meanwhile neo-banks should focus on their attempts to establish low-cost sources of funding. They should engage with small and medium enterprises and improve their features to retain customers.
Digital banking has the potential to propel Indonesia’s economy into the future and unlock its full potential. The inclusion of more consumers into the financial system would deepen the shallow domestic financial market, increasing overall bank liquidity and resilience. High frequency data would enable more accurate credit analysis, increasing the efficiency of digital banks and improving their asset quality. Lowering digital banks’ overhead costs would reduce their credit rates, increasing the amount of credit in the economy and enabling neo-banks to eventually make sustainable profits.
Suryaputra Wijaksana is an Economist at Bank Central Asia in Jakarta, Indonesia.
Juan Tarigan Tetangena is an Economist at a Public Institution in Jakarta, Indonesia.