Authored by: Justin Choi, Charles Chua, Antonio Panis
Edited by: Jared Go, Elijah Soriano, Andrei Dimaculangan
Source: Gemini
Introduction
Interest rates for savings accounts represent the money that the bank pays you on your deposits. Typically, the vast majority of people would leave their savings in a traditional bank, such as BDO or BPI. However, in recent years, the Fintech industry has become a staple, with around 41 million Filipinos having access to digital banking (Vera, 2022).
Given that digital banks tend to offer higher interest rates, more and more people are seemingly flocking to them, choosing it as their way to grow and safeguard their extra income. However, there are also those who prefer to play it safe by sticking solely to traditional banks.
Traditional banks
In the traditional banking system, savings accounts are the most basic yet most consequential financial product. At its core, a client allows the bank to take custody of their money in exchange for a predetermined interest rate set by the bank. The average deposit interest rate is 1-2% per annum, significantly varying depending on the bank (Selected Domestic Interest Rates, 2023). This is a good deal for clients as physically storing money comes with risks such as theft, and natural/artificial hazards. Furthermore, storing money physically at home comes with the opportunity cost of using it to generate extra income. By depositing their money to a large financial institution, they can not only insulate themselves from these risks but also earn additional cash in the form of a deposit interest rate.
For traditional banks, it is an even better deal: by taking custody of a client’s savings, they can use their savings to lend it out to various clients, whether it be individuals, businesses, governments, and other financial institutions, at a substantially higher interest rate of 8% (Selected Domestic Interest Rates, 2023). By borrowing money from savings at a low rate, and lending it out at a high rate, traditional banks are able to generate strong net interest margins.
Figure 1. Banking Sector Loan Breakdown (in %)
Source: S&P Global Ratings
As shown above, banks are primarily focused on large institutions, with only a small percentage of loans being allocated to purposes related to ordinary consumers. Given this loan composition, banks are able to attain a consistent and stable flow of cash. However, due to lower risk profile and limited demand for clients, the amount by which banks can raise interest rates is limited, which in turn puts a constraint on profit growth (Gambacorta, 2024). Nonetheless, the sector has done relatively well recently due to the effect of central bank interest rate hikes, with BDO Unibank able to set a new record-high net income over the entire Philippine business sector (Camus, 2024).
Digital banks
Digital banks operate almost exclusively online while being able to offer similar retail services to that of a traditional bank. Due to the nature of their operations, in theory digital banks are not inclined to pay for several overhead costs that would be synonymous to that of a traditional bank, such as rent, utilities, and can reduce payouts to certain types of staff such as bank tellers. The money saved from having less overhead costs can be used to provide higher interest rates, allowing more people to learn about and use certain specific digital banks rather than others. As a result, savings accounts at these banks may become more attractive to consumers relative to traditional banks. In some instances, digital banks offer up to 10% per anum, which is more than double the national annual average of 3.68% to 5.14% (Fintech News Philippines, 2023).
Moreover, digital banks have a better chance to financially include the underserved populations in the country that have been overlooked by traditional banks (De Gantès et al., 2023). The lack of a substantial credit history, and their low-income status have led them to be neglected by traditional banks. However, this can be an opportunity for digital banks. The higher interest rates offered by the digital banks could further encourage them to engage with their services.
While these factors are great for digital banks, it is important to highlight the risks they face as well.
Figure 2. Digital Banking Loan Breakdown (in %).
Source: S&P Global Ratings
Majority of loans that Philippine digital banks have given out are primarily concentrated in personal loans or in other words, unsecured loans. Unsecured loans are a type of debt obligation that is not backed up by collateral in the event that the debtor defaults. This, combined with generally lower asset quality of digital banks indicates higher default risk for the sector.
Figure 3. Costs and Profitability of Digital and Traditional Banks (in %).
Source: S&P Global Ratings
While digital banks have the advantage of lowering costs in certain areas due to operating digitally, a closer look at data shows that they still face higher costs which in turn impacts profitability. Most notably, higher interest rates on savings accounts leads to lower net interest margins, and the aforementioned reliance on unsecured loans requires higher provisioning costs.
These challenges, coupled together, present a negative outlook on the financial health of these digital banks. According to the BSP, only two of the six Philippine digital banks are profitable at present day. Furthermore, it may take around five to seven years for a digital bank to become profitable (Cigaral, 2024).
Conclusion
Traditional banks have remained relatively stable and provide a safe place for people to store their cash. Digital banks provide great financial opportunities for consumers, such as higher savings interest rates, and more accessibility to loans. However, the strain that this puts on digital banks may result in a longer duration of risks in their financial health until they can stabilize. Ultimately, consumers should carefully consider the opportunities and risks presented by these financial institutions and understand how they can fit their overall savings strategy.
References:
Cigaral, Ian. (2024, March 8). BSP: Only two of six PH digital banks are profitable. Inquirer. Retrieved April 1, 2024 from https://business.inquirer.net/449038/bsp-only-2-of-6-ph-digital-banks-are-profitable
Camus, M. R. (2024, February 27). BDO shatters PH income records. Inquirer.net. Retrieved April 1, 2024, from https://business.inquirer.net/447436/bdo-shatters-ph-income-records
De Gantès, Gerson, & Romano. (2023, May 3). On the verge of a digital banking revolution in the Philippines. McKinsey & Company. Retrieved March 21, 2024, from https://www.mckinsey.com/industries/financial-services/our-insights/on-the-verge-of-a-digital-banking-revolution-in-the-philippines
De Vera. (2022, February 17). 41 million Filipinos now have banking, e-money access . INQUIRER.NET. Retrieved March 21, 2024, from https://business.inquirer.net/341084/41m-filipinos-now-have-banking-e-money-access
Gambacorta. (2004, February). HOW DO BANKS SET INTEREST RATES? Retrieved March 21, 2024, from https://www.nber.org/system/files/working_papers/w10295/w10295.pdf
Income Statement. (2023). Bangko Sentral ng Pilipinas. Retrieved March 21, 2024, from https://www.bsp.gov.ph/Statistics/Financial%20Statements/Income%20Statement/13_data.aspx
Fintech News Philippines. (2023, June 5). How Competitive Are Interests Rates Offered By Philippines’ Digital Banks? Retrieved March 21, 2024, from https://fintechnews.ph/58583/virtual-banking/how-competitive-are-interests-rates-offered-by-philippines-digital-banks/
Klapper, Singer, Demirgüç-Kunt & Ansar. (2022). The Global Findex Database 2021. The World Bank. Retrieved March 21, 2024, from https://www.worldbank.org/en/publication/globalfindex
SELECTED DOMESTIC INTEREST RATES. (2023). Bangko Sentral ng Pilipinas. Retrieved March 21, 2024, from https://www.bsp.gov.ph/Statistics/Financial%20System%20Accounts/tab19_dir.aspx
S&P Global Ratings. (2024, March 27). Sector Update: Key Credit Risks For Philippine Banks,
Economy And Sovereign Ratings. Retrieved March 28, 2024, from https://www.spglobal.com/ratings/en/events/webcast-replays/sector-update-key-credit-risks-for-philippine-banks-economy-and-sovereign-ratings-mar-27-2024-
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