Virtual Banks Forge Path to Sustainability

Since the initial excitement surrounding their launch has subsided, Hong Kong’s eight virtual banks have faced increasing competition from traditional banks, which continue to invest heavily in their digital banking capabilities as they strive to stay ahead of the curve. Virtual banks faced other challenges in 2022 as they navigated through economic uncertainties and the impact of Covid-19.

But despite these headwinds, in their second full year of operation most of the new virtual banks saw an improvement in financial performance with a reduction in losses before tax as they moved further along the path to sustainability. They also made efforts to finesse their brand identity and to seek opportunities in new areas, notably wealth management and insurance.  

Traditional banks have responded to the arrival of virtual banks in Hong Kong by amplifying their own digital transformation efforts to maintain their position as the preferred choice of banking service provider. In particular, they are aiming at capturing the younger, affluent and digitally savvy demographic, and some traditional banks have made significant progress in this area. For instance, HSBC’s mobile banking application saw an increase of 90% in net growth of active millennial users compared to the previous year¹. 

There has also been a growing trend of traditional banks focusing more on their digital footprint by merging, relocating and even closing some physical branches as customers’ needs can increasingly be met via digital means².

In 2022, even amid market challenges, virtual banks continued to see growth in the number of accounts opened, reaching 1.7 million as of October 2022³. However, the growth rate was more muted than in 2021. The total number of accounts grew 42% from the fourth quarter of 2021 to the third quarter of 2022 (latest available data), as compared to 186% from the fourth quarter of 2020 to the fourth quarter of 2021.

In terms of financial performance in 2022, all virtual banks continued to report a loss before tax, albeit with slight improvements from the previous year’s results for six out of eight virtual banks.

Ping An OneConnect Bank and Airstar Bank had the best performance results relative to the other virtual banks, as indicated by the largest percentage decrease in loss before tax compared to 2021 (27% and 18% respectively), while also reporting the smallest loss before tax in absolute terms. This better performance was notably driven by their higher net interest margins.

The total combined gross loans offered by the virtual banks increased significantly from HK$6 billion in December 2021 to HK$16 billion in December 2022, as all virtual banks deployed more deposits into lending, evidenced by a higher overall loan-to-deposit ratio of 54% compared to 25% in the previous year. 

Nonetheless, higher loan sizes did not always correlate strongly to higher profitability during 2022. For instance, Ping An OneConnect Bank increased its loan-to-deposit ratio by 1 percentage point to 84% and saw a decrease in loss before tax of 27%, making it the best performer among the virtual banks. In stark contrast, Fusion Bank increased its loan-to-deposit ratio by 23 percentage points to 28%, but had an increase in loss before tax of 22%. 

To improve profitability and become sustainable, virtual banks will need to factor in other parameters aligned with their individual cost optimisation strategies.

Except for ZA Bank and Mox Bank, which continued to grow their deposits substantially and deploy those into lending, the other six virtual banks experienced much slower, or even negative, growth in deposits in 2022. In some cases, however, this has been a strategic decision. Virtual banks are aware that unrestrained growth in deposits may adversely increase their cost of funds, so some have decided to limit deposits taken and to strike a balance adapted to their individual risk appetite.  

All in all, as the Hong Kong banking landscape becomes ever more competitive, it is imperative for virtual banks to keep innovating and implement strategies to attract and retain customers if they are to become profitable. While in the short run some virtual banks may be able to benefit from parental support, they ultimately need a credible path to profitability. As such, we maintain our view that some virtual banks could quietly cease operations or consolidate their operations over the next few years.

In 2022, most virtual banks made efforts to solidify their brand identity and market positioning.

ZA Bank, WeLab Bank, Mox Bank and Ant Bank primarily cater to the mass retail market through a range of new products and services such as credit card statement instalment programmes. Meanwhile, Airstar Bank and Ping An OneConnect Bank aim to capture a slice of the market for lending to small and medium-sized enterprises (SMEs), particularly those that may find it difficult to meet traditional lending requirements. 

For instance, Ping An OneConnect Bank partnered with an e-commerce company to launch Trade-Connect Loan, which extends pre-approved loans of as much as HK$5 million, predominantly to export-import-oriented SMEs. Such loans can help to ease the financing needs of underserved or unserved smaller businesses in Hong Kong⁴

Moreover, ZA Bank, with the ambition of becoming the go-to bank for Web 3.0 crypto start-ups, has recently been pushing into transfers of crypto and fiat currencies by looking to offer token-to-fiat currency conversions with licensed exchanges⁵. ZA Bank has also been forging a path in international transfers. In partnership with a global technology company, it has become the first virtual bank in Hong Kong to offer international transfers with no foreign exchange mark-ups or hidden fees. This service was launched in November 2022⁶.

Virtual banks hope to venture into wealth management and insurance and capitalise on the rising trend of online distribution of such products and services. Younger customers in particular value the convenience of being able to conduct research and purchase investment and insurance products and services with a just few clicks. This is evidenced by the strong growth in the number of investment transactions and long-term insurance policies sold via digital channels in the past few years⁷.

Fusion Bank, WeLab Bank and ZA Bank obtained the necessary licenses from the Securities and Futures Commission in 2022 to start offering wealth management products and services to customers, while Livi Bank followed suit in early 2023. 

ZA Bank and Livi Bank were both granted the Insurance Agency License from the Insurance Authority to enable them to add fee-based insurance products and services to their range of offerings. More specifically, ZA Bank has collaborated with a fellow group company to offer health and life insurance products to customers⁸, while Livi Bank has leveraged its existing partnerships and network of shareholders to launch home and travel insurance products⁹. 

While more investment and insurance licenses may be granted to virtual banks in 2023, they will also need to be wary of offering too many diverse products or services, which could risk confusing or diluting their brand identity.

In 2022, the eight virtual banks in Hong Kong continued to operate at a loss amid market uncertainties and strong competition from traditional banks. However, most virtual banks were able to improve their financial performance relative to the previous year.

To succeed in Hong Kong and turn their losses around, virtual banks will need to continue to be innovative and responsive to industry changes. 

The key to achieving this is through asserting their brand identity and positioning, whether that would be in the mass retail market, SMEs lending segment or via new products. It remains crucial for virtual banks to define and communicate their value proposition to customers clearly in order to pave a path to sustainability.