Digital Banking

Uphill Climb for Philippines Digital Banks to Shift Banking Status Quo

In the Philippines, the emergence of digital challenger banks has been a promising development, particularly given the country’s significant unbanked population. Fitch Ratings observes that while these digital banks have seen rapid growth since their introduction, their overall market share remains small. They are not expected to substantially alter the competitive dynamics of the Philippine banking sector in the medium term, nor significantly impact the ratings of established banks.

As of the end of June 2023, the collective market share of challenger banks in terms of system deposits in the Philippines was under 0.4%. This figure, alongside the relatively low average deposits per customer, indicates that these banks have not yet made a significant inroad into their depositors’ primary operating accounts.

Looking ahead, Fitch anticipates that digital banks will continue to aggressively compete for deposits over the next couple of years as they aim to refine their business models and achieve necessary operational scale. Many of these banks are currently engaging in price competition, with some offering promotional deposit rates up to 15%, a stark contrast to the more typical 4%-5% time-deposit rates. However, in a context of rising interest rates, this approach might not be sustainable in the long run, even though it may support short-term segment growth.

Digital banks that have the backing of established corporations, with broad customer bases and complementary business lines, are thought to have an advantage in the longer term. These banks are being influenced by high funding costs to lend to higher-yielding, but riskier, segments such as unsecured personal and SME loans.

While this strategy could help maintain positive credit spreads, most digital banks are expected to continue incurring losses in the near term due to high credit costs and the investments required to expand their customer base and develop their franchises.

The retail loan quality in the Philippines, traditionally more volatile and weaker than corporate loans, presents a significant challenge. Digital banks, with their focus on higher-risk segments and the underbanked population, have a notably higher average non-performing loan (NPL) ratio of 8.5% as of September 2023, in comparison to the 3.5% average of the broader banking system.

Despite these challenges, the Philippines’ strong economic growth prospects, with an expected average real GDP growth of 6.3% per year over 2024-2025, could improve borrower repayment capacities and overall asset quality for both digital and incumbent banks. However, the unique characteristics of digital banks’ loan books and customer bases may expose them to greater risk in the event of an economic downturn outside of Fitch’s expected baseline scenarios.