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The Digital Bank Hype, MFS Lessons, and The Dilemma Of Traditional Banks 

Traditional banks in Bangladesh failed to build a dominant mobile financial service (MFS) despite enjoying a favorable regulatory environment. If they follow a similar playbook, they will also fail in the digital banking race. This time, failure will be more costly than MFS failure.

In business and life, nothing fails like success. Success can induce complacency, stir hubris, and cause lethargy.

In business, success breeds the innovator's dilemma—the reason highly successful businesses go out of business. Nokias of the world lament, "We didn't do anything wrong, but somehow, we lost."

It takes extraordinary courage and discipline to overcome these challenges, particularly when one is successful. That's why few organizations can truly defeat challenges like the innovator's dilemma and continue to innovate.

I have written about innovators' dilemmas in the Bangladeshi corporate world for a fair bit. One ongoing dilemma is the MFS sector, where, despite having a favorable regulatory regime, main stakeholder banks have so far failed to build any significant success. Instead, bKash, a relatively independent player, has captured the bulk of the market.

Sometimes, leverage can be costly.  

The failure of banks in the MFS market makes a compelling case today as we enter a frenzied discussion around digital banking in the country.

I. The Dilemma 

Similar to MFS, banks have a relative advantage in building digital banks in the existing regulatory framework. Traditional banks retain their opportunity to build internet banking services. They also enjoy other subtle regulatory favors.

However, given past experience with MFS and other digital initiatives, I contend that most traditional banks are unlikely to succeed at building a dominant digital bank if they try to do it themselves.

However, given past experience with MFS and other digital initiatives, I contend that most traditional banks are unlikely to succeed at building a dominant digital bank on their own.

By that, I mean two things. Firstly, traditional banks are unlikely to be able to completely transform themselves into digital banks. The regulatory framework doesn’t allow that either — digital banks have to be fully branchless. So, that is a moot point. Moreover, except for a minority few, many will even struggle with building a meaningful online banking business that will be able to compete with a full-fledged digital bank. Secondly, if they want to build a digital bank as a subsidiary under the leadership of the traditional bank, they will not be able to do it either.

The reason behind my contention is not related to capabilities, understanding, or willingness to invest.

In fact, traditional banks are uniquely capable and positioned to build dominant digital banking services. Many traditional banks today have decent internet banking services, and they can expand that service into strong competitors to digital banks. Moreover, their existing market position, brand image, and offline presence should help them build out these digital banking services more effectively.

Unfortunately, along with the advantages, traditional banks also suffer from unique and insidious structural and strategic limitations. And that is where my argument comes from.

The main challenge comes from the fact that many traditional banks that are interested in digital banks are highly successful businesses. And success can truly be catastrophic for businesses if you allow it to get to you.

I have a three-pronged thesis behind my reasons.

Firstly, cannibalization — digital banks will essentially disrupt and cannibalize the existing banks to a certain extent. Traditional banks do not want that. Instead, most traditional banks will try to avoid it.

Secondly, the innovator's dilemma is real. Successful businesses often prioritize maintaining their existing success, instead of investing in an emerging opportunity that may or may not succeed in the long run.

Finally, the long-term investment requirement is a challenge. Building a successful digital bank will take a long time and banks are unlikely to invest in a loss-making entity for years.

However, this time around the challenge is more complex for traditional banks. If you don't cannibalize yourself, somebody else will.

This puts banks in a spot and forces their hand, which apparently has led to some heightened discussion among traditional bankers regarding building digital banks and is likely to lead to some initiatives.

Unfortunately, because of the challenges mentioned above, traditional banks will not be able to operate freely when it comes to building a digital bank. Their efforts will be inconsistent, which will likely lead to a subpar outcome.

This much is already apparent in recent discussions with bankers. More on that in a moment. Before that, let’s take a detour through the banks’ MFS failure.

II. The MFS Lessons 

We discussed the banks' MFS performance, which offers a glimpse into the challenges banks face in dealing with innovation and successfully building outside of their core business.

There is an uncanny resemblance between the current digital bank frenzy and the similar hype surrounding the MFS service in 2011.

When mobile financial service (MFS) was introduced in 2011, 27 banks received approval from the central bank. By 2016, 19 of them had launched a product. Currently, 13 entities are active in the market.

Dutch-Bangla Bank launched the first MFS service, DBBL Mobile Banking, in March 2011. It has since been rebranded to Rocket. The service had a promising start with great fanfare, only to eventually succumb to mediocrity.

bKash, a subsidiary of BRAC Bank, was launched three months later. In the following years, several other banks introduced MFS services. While DBBL's Rocket saw several ups and downs, no other bank-led players came close to dominating the MFS market.

Currently, bKash is the leader in the market while other MFS operators continue to struggle to find a growth path. Rocket, the sole bank-led player in the top three, owns a meager market share. bKash and Nagad dominate the sector with over 75% market share between them in terms of customers and 85% share in terms of transactions.

MFS has gone mainstream in Bangladesh over the last decade. Despite having regulatory advantages, bank-led MFS services have largely failed to build a significant position in the market.

Well, one can say that bKash has done it, and it is a BRAC Bank subsidiary. The reality is that bKash is a unique story, and that's why the question regarding the performance of the other bank-led MFS players comes up.

I wrote about this before. This begs the question: Why? While many people want to say that “the reluctance to invest, a lack of skilled workforce, and the dominance of two to three players” are the reasons behind this, the problem is much deeper. These are merely symptoms of a bigger problem.

Reluctance to invest is a decision-making and commitment problem. Dealing with competition effectively is a function of how well-run a company is. If your trifecta of business—market, operation, and capital—are in place, competition should never kill your business.

The real reason for the failure of most bank-led MFS services is that they are owned and operated by banks. These companies, although the majority are independent subsidiaries, almost always depend on their parent company for important decisions and investments.

MFS is not something you can make happen overnight. Initially, the growth can be slow. The size of the business can look insignificant compared to the balance sheet of a well-run bank. The whole thing might look like a bad idea and a bad investment to the CFO and business-savvy board members of a bank.

While your core business, which is a bank, generates a huge return, why should you invest in something that is struggling and doesn’t show equal potential? Why should you not instead invest in growing your core business—which is banking? A legitimate business question for any well-run company. A dichotomy that many well-run companies go through and why many well-run companies fail to innovate.

In our case, ultimately, as a well-run bank, you decide not to invest in the MFS company. You decide to focus on your core business. A few years later, the MFS service that you deprioritized became a huge success. It disrupted the banking industry and forced your bank to change its business model.

This is a classic example of the innovator's dilemma. Your existing business is so successful that you don't feel like investing in a new product that is not bringing large enough success in a short enough time. Even though the second product can become a huge business in the long run.

This is what happened with almost all the bank-run MFS players. Many of these players started with high hopes. Some of them even made meaningful investments in the early few years. There are still bank-led players who are making meaningful investments these days. But none of these players operate with enough independence. The parent banks still call all the major shots.

In most of these instances, the complex thing is that if a bank decides not to invest heavily in its MFS business, it is a perfectly logical and rational business decision. Why should you invest in a losing project instead of the one that is winning? This is the core challenge of the bank-led MFS players. 

Decisions are often viewed and made through the lens of the parent bank's business. The bank's own interest predominates the interest of the MFS itself. Often, the question is not whether this decision would benefit the MFS to get to the next stage. Rather, the question is always whether the decision to invest more money in the MFS makes sense for the bank.

Contrast that with the country's MFS leader, bKash. bKash is a subsidiary of BRAC Bank, but that is where the relationship ends. bKash is a founder-led organization. Kamal Quadir founded bKash, and he continues to run it to this day. While bKash has people from BRAC and BRAC Bank on its board, the decisions are not made by BRAC Bank and are never viewed through the BRAC Bank lens.

Not only does bKash operate with complete independence, but it has mostly charted its own path throughout its journey. It has raised strategic investments from investors like the Bill and Melinda Gates Foundation, Alibaba, and SoftBank, among others. bKash has been operating like a startup since its inception, not as a mere subsidiary of some bank and part of a larger organization.

I think the success and failure in the emerging digital bank landscape in Bangladesh will mirror the MFS journey.

III. The Digital Bank Hype 

Let's get to our main discussion of the day, which is digital banks, and see how this MFS saga connects with it.

Since June, when the Bangladesh Bank approved the digital bank guideline, digital banks have become one of the most talked-about topics in Dhaka’s tech and business community. According to the The Business Standard (TBS):

“A total of 52 domestic and foreign entities have filed applications for a licence to set up digital banks, when the Bangladesh Bank initially intends to extend permits only for two or three banks.”

Apparently, all kinds of companies are interested in digital banks, “ranging from commercial banks and mobile financial services (MFS) to ride-sharing and food delivery platforms, IT service providers, and even pharmaceutical companies.”

The report mentions some of the applicants. From TBS

“A consortium of 10 private sector banks in the country has collaboratively taken the initiative to launch a digital bank named 'DG10 Bank PLC. The banks are – City Bank, Mutual Trust Bank (MTB), Eastern Bank Limited (EBL), Dutch Bangla Bank Limited (DBBL), Trust Bank, Prime Bank, Pubali Bank, National Credit and Commerce Bank (NCCB), Mercantile Bank and Midland Bank. Four state-owned banks - Sonali, Agrani, Janata, and Rupali – also want to set up another digital bank.

State-run Mobile Financial Service (MFS) provider Nagad, bkash, mobile operator Banglalink, and digital services company Pathao have applied to get the licence to set up a digital bank as well.”

According to the Bangladesh Bank guidelines, digital banks will operate without any branches, sub-branches, or ATM booths. Banking services will be provided to customers solely using mobile and digital devices, without any in-person transactions. The minimum capital requirement for a digital bank is set at TK 125 crore, while a conventional bank requires TK 500 crore to get the license.

An overwhelming number of applications have come from traditional banks, either independently, jointly with other banks, or in partnership with third parties. Traditional banks are apparently interested in digital banking. 

We have also come to know some aspects of how traditional banks are thinking about digital banks over the past months.

The Business Standard (TBS) published a fascinating interview with the City Bank Managing Director and CEO Mashrur Arefin, one of the 10 banks that jointly applied for a license to set up a digital bank tentatively named Digi10. The interview offers a glimpse into the mindset of traditional banks and bankers toward digital banks.

From the TBS interview with City Bank MD and CEO Mashrur Arefin:

“There is such a huge misconception about digital banking vis-à-vis conventional banks going digital. It pains me. The fact is, a conventional bank with its conventional mindset, its physical presence-related cost structure, its culture of necessary bureaucracy, its knack for financing large-size projects, etc., can never turn into a digital bank. Never. At most, what it can do is offer its full suite of retail banking, small and microfinance, and card products through people's phone sets. That's classical ‘internet banking’ — where a brick-and-mortar conventional bank basically creates a complementary channel for its product and service offerings to individual people, not so much to business houses.”

It is partly true that conventional banks are not designed to become digital banks because of their cost structure, operational mechanics, and mindset. However, they can and do offer internet banking services to complement their brick-and-mortar services. It is within the reach of traditional banks to turn their internet banking to the level where they can compete with independent digital banking services.

To that end, I think Mr. Arefin is only half right for several reasons. In fact, I think given the fact that conventional banks have the opportunity to explore internet banking, which is the entirety of digital banking, they should not invest in digital banks separately. They are already better positioned to build digital bank alternatives.

The problem is that conventional banks are not good at internet banking either. The current state of the internet banking experience is quite poor. Only a few banks have managed to offer a satisfactory internet banking experience. This then makes digital banks a potential challenge for traditional banks. As a result, many conventional banks may see digital banks as a remedy to that predicament. More on that in a moment.

Mr. Arefin then goes on to explain why the internet banking service of a traditional bank will not be able to compete with a digital bank:

“Citytouch, even with its best level of capabilities, is nothing but an extension of a traditional bank's service channel – which is good, but the thing is, the digital potentials of a bank can't be achieved by putting your foot into the traditional mud at the same time.”

However, I can’t stop thinking that if traditional banks can’t build out their internet banking services and scale it, how and why will they be able to build a digital bank? Will not traditional banks face a similar challenge when it comes to building digital banks? 

The conversation gets truly interesting when the interviewer asks Mr. Arefin about transitioning traditional bank customers to digital banks:

“Why should I talk about luring existing bank customers to digital banks rather than offer them more on Citytouch-like mobile banking platforms and retain them there? It's a large economy so you better go hunt for new customers for your digital banks. Look at the customer base of BKash which is about 6 crore people. Look at the buying and selling activities that are happening at retail and small business levels across the 495 upazilas and 88,000 villages. That's like another Bangladesh, which the traditional banks have not necessarily looked into in a meaningful way.”

This reveals part of the real challenge traditional banks face. 

IV. The Real Challenge for Traditional Banks 

Traditional banks do face limitations of bureaucracy and structure, but it would be disingenuous to claim that traditional banks will not be able to offer an alternative to digital banks because of that.

The real reason traditional banks fail and will fail at digital banking is because of their complacency and the innovator's dilemma, both of which come from their current success.

Unfortunately, traditional banks find themselves eerily in a similar conundrum they faced with mobile financial services (MFS) a decade ago. An honest examination of banks' MFS lessons should help many bankers see this digital bank dilemma with greater clarity.

Traditional banks don't want to disrupt their existing business. Mr. Arefin's point about the target customer of digital banks makes it clearer that traditional banks don't want digital banks to serve existing bank customers.

My earlier points about why traditional banks will face a serious challenge building digital banks under the same leadership become even clearer when you pay attention to the discussions with bankers today.

I mentioned three reasons for my skepticism about whether traditional banks will succeed at building digital banks: the risk of cannibalization, the innovator's dilemma, and long-term investment requirements. 

Discussions from traditional bankers regarding digital banks are littered with the scent of these three and many more contradictions.

Let's take a look at my key points on why traditional banks run a risk of failure.

Risk of cannibalization: Digital banks will eventually serve many of the same customers that traditional banks now serve, which means digital banks will eventually come to disrupt at least a certain segment of traditional banks.

Logically, traditional banks don't want to disrupt their existing business, which is a hugely successful one. This means that if traditional banks invest in or run a digital bank, they will design the strategy in a manner that does not cannibalize their existing business.

Mr. Arefin was quite explicit about this in his TBS interview:

“Why should I talk about luring existing bank customers to digital banks rather than offer them more on Citytouch-like mobile banking platforms and retain them there? It's a large economy so you better go hunt for new customers for your digital banks.”

Now, as a bank, you can decide that you will not serve the urban population who are customers of existing banks. Rather, you will go for the unbanked population. But customers might have something else in mind.

One prime customer segment for services like digital banking is tech-savvy young people, who currently predominantly use traditional banking services. They will be the first to jump ship from the traditional banking boat if they find a better alternative. This will likely complicate strategic decisions for a digital bank run by traditional banks.

Of course, customers of traditional banks can use the internet banking services of their banks, such as City Touch for City Bank. However, if traditional banks want that to happen, they will now have to compete with the standard of digital banks, a likely uphill battle given the past performance of traditional banks in offering high-quality internet banking experiences.

The risk of cannibalization is a strong motivation for traditional banks not to invest sincerely in digital banking. As Mr. Arefin rightly pointed out, mindset is a critical barrier for traditional banks.

Moreover, every model and system eventually creates its own beneficiaries, who then ensure that the model survives. It is the same for traditional banks.

The branch-based model, although perhaps not always a healthy business decision, will continue to survive because the beneficiaries of the existing system do not want to rock the boat. 

Similarly, most changes do not happen because of systemic inertia. We simply get used to the status quo and do not feel like changing it, even though we fully understand that the existing system is not beneficial for us.

Unfortunately, whether traditional banks want to accept it or not, digital banks will eventually come to bite the traditional banks and their market share, and will eventually force the hands of traditional banks to do something about it. If we do not cannibalize ourselves, someone else will, and when that happens, we will not like it.

Innovator's dilemma: Many bankers and their owners are interested in digital banks because the license fees and paid-up capital are minimal. They don't see digital banks as something that could potentially surpass existing banking businesses. Some see it as an opportunity to expand the banking to the unbanked population. Moreover, digital banks, at least in their early days, are going to be an investment without much immediate return. 

The skepticism about digital banks is not entirely out of place. Various digital services continue to see at best sluggish growth in Bangladesh. However, that’s a discussion for another. 

Compared to the balance sheet of the traditional bank, most banks would find the opportunity unenticing. Instead, many banks would think that their existing successful banking business offers a higher return on investment. 

This is exactly what happened with bank-led MFS services. With digital banks, this problem is even more pertinent and the long-term risk of disruption is higher for the traditional banks. I have written about the innovator’s dilemma several times in the past. 

From The Real Challenge of Bank-led MFS Players, Innovator's Dilemma, and Corporate Innovation

“Late Harvard Professor Clayton Christensen published Innovator’s Dilemma in 1997. The book is often called one of the most — if not the most — important books in business and innovation. In the book, Christensen offers a compelling argument about why successful incumbents fail to innovate:

“The reason [for why great companies failed] is that good management itself was the root cause. Managers played the game the way it’s supposed to be played. The very decision-making and resource allocation processes that are key to the success of established companies are the very processes that reject disruptive technologies: listening to customers; tracking competitors actions carefully; and investing resources to design and build higher-performance, higher-quality products that will yield greater profit. These are the reasons why great firms stumbled or failed when confronted with disruptive technology change.

Successful companies want their resources to be focused on activities that address customers’ needs, that promise higher profits, that are technologically feasible, and that help them play in substantial markets. Yet, to expect the processes that accomplish those things also to do something like nurturing disruptive technologies – to focus resources on proposals that customers reject, that offer lower profit, that underperform existing technologies and can only be sold in insignificant markets– is akin to flapping one’s arms with wings strapped to them in an attempt to fly. Such expectations involve fighting some fundamental tendencies about the way successful organizations work and about how their performance is evaluated.”

Clearly, this is the position traditional banks find themselves in when it comes to digital banking. When a board of a bank finds that investing in its banking business is more profitable for the bank than investing in a digital bank in the short term at least, because that's all we can see, they make the logical decision that any astute business executive would make.

Long-term investment requirement: You will not be able to build a digital bank in a year or two. It will likely take 10-12 years to get to a point where you see a large successful business. Very few traditional banks will agree to invest in something for that long. 

Final thoughts 

Traditional banks in Bangladesh missed the MFS train. Over the last decade, mobile financial services (MFS) have become a force in the financial landscape in the country. As MFS services expand and mature further, they will create real challenges for the banks. Some bankers do regret that they missed that train. Others are now seeing MFS as a meaningful distribution partner.

Digital banks pose an even greater threat to traditional banks. Successful digital banks will essentially cannibalize traditional banks.

The advantage that traditional banks have is that they can build and scale their internet banking services and combine that with their offline services, creating an effective moat against the up-and-coming digital banks.

Digital banks will certainly start with the disadvantage of the lack of offline presence in a country where people still prefer offline over online in most cases. However, this trend is changing and there is a growing set of consumers who are now accustomed to online services.

Moreover, services like bKash have essentially commoditized the trust in financial products. People are familiar with mobile phone-based financial services.

The wise thing for banks who are serious about investing in digital banks would be to follow a bKash-type model, where a bank partners with a passionate entrepreneur who wants to build a digital bank instead of trying to do it themselves. This is an obvious lesson for many banks who tried to build MFS in a somewhat sporadic manner.

If traditional banks use the same playbook as they did for MFS, they will likely end up with the same result.

Many successful banks in Bangladesh are perfectly positioned and capable of building successful digital banks. However, the capability is only part of the game. 

The real challenge for traditional successful banks will come from whether they can overcome the innovator's dilemma. Sometimes, success can be hard to overcome.

Mohammad Ruhul Kader is a Dhaka-based entrepreneur and writer. He founded Future Startup, a digital publication covering the startup and technology scene in Dhaka with an ambition to transform Bangladesh through entrepreneurship and innovation. He writes about internet business, strategy, technology, and society. He is the author of Rethinking Failure. His writings have been published in almost all major national dailies in Bangladesh including DT, FE, etc. Prior to FS, he worked for a local conglomerate where he helped start a social enterprise. Ruhul is a 2022 winner of Emergent Ventures, a fellowship and grant program from the Mercatus Center at George Mason University. He can be reached at ruhul@futurestartup.com

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