Malaysia inched forward to licensing the first digital banks (DGs) in the Islamic Development Bank (IsDB) member countries, when Bank Negara Malaysia (BNM) issued a Policy Document on Licensing Framework for Digital Banks on 31 December 2020 following a six-month public consultation. BNM’s approach is based on a step-by-step phased introduction of various thresholds.
The framework, says BNM, “aims to enable the innovative application of technology to uplift the financial well-being of individuals and businesses and foster sustainable growth. This includes expanding meaningful access to and promoting responsible usage of suitable financial solutions to unserved and underserved segments.”
The framework, adds the central bank, adopts a balanced approach to enable admission of digital banks with strong value propositions whilst safeguarding the integrity and stability of the financial system as well as depositors’ interests.
To achieve these outcomes, a simplified regulatory framework will be applied to digital banks during the initial stage of operations, commensurate with an asset threshold of not more than RM3 billion for three to five years. “This functions as a foundational phase for the licensees to demonstrate their viability and sound operations, and for the Bank to observe the performance of the licensed digital banks and attendant risks that arises from their operations.”
In complying with the asset limit, BNM requires the licensed digital bank to monitor its off-balance sheet items to ensure any potential crystallisation of off-balance sheet items into on-balance sheet items does not result in a total size of assets that exceed the asset limit.
Digital banks will be required to comply with the requirements under the Financial Services Act 2013 (FSA) or Islamic Financial Services Act 2013 (IFSA), including standards on prudential, Sharia’a governance, business conduct and consumer protection, as well as on anti-money laundering and terrorism financing. During the foundational phase, licensed digital banks will be subjected to a more simplified regulatory requirement relating to capital adequacy, liquidity, stress testing, Sharia’a governance and public disclosure requirements.
Currently there are no dedicated Sharia’a compliant digital banks anywhere in the world. Currently, Albaraka Türk Participation Bank, which established a Sharia’a compliant digital offshoot, Insha in Germany in 2018 with a €5 million investment, though it does not have a standalone full banking licence. In October 2020, Turkish payments provider Param invested a further €2.5 million in Insha, which currently has over 45,000 users with a transaction volume of about €30 million. Other initiatives on the cards include MyMy in Malaysia and IBA in Australia, which hopes to get a licence from the Australian Prudential Regulation Authority in 2021.
BNM has invited applications to conduct digital banking business or Islamic digital banking business from qualified parties. These will have to be submitted to the central bank no later than 30 June 2021. Up to five licences may be issued to qualified applicants who will have to wait till the First Quarter of 2022 when notification on the grant of licence will be made.
The policy document sets out the requirements relating to applications for the establishment of a digital bank, including the eligibility requirements and application procedures that must be complied with by an applicant intending to carry on digital banking business or Islamic digital banking business; the business limitations and regulatory framework applicable to a licensed digital bank during the foundational phase; and the business activities that must be undertaken and the physical access points that may be established by the licensed digital bank.
Existing licensed banks or licensed Islamic banks may apply to carry on digital banking business or Islamic digital banking business through a separate corporate body, such as their subsidiary or through a joint venture arrangement with another party. However, says BNM, “this does not preclude existing licensed banks and licensed Islamic banks from digitalising their current business operations, which does not require the application of a separate licence under this policy document.”
The policy framework is a comprehensive and robust document incorporating the spectrum of requirements ranging from shareholder suitability and eligibility criteria; business plans; products; prudential, supervisory and regulatory oversight; Sharia’a governance; IT and digital structures and capabilities; to even exit strategies.
The framework defines Islamic digital banking business as “Islamic banking business as defined in section 2(1) of the IFSA which is carried on wholly or almost wholly through digital or electronic means, carried out by “a person licensed under section 10 of the IFSA to carry on Islamic digital banking business.”
The phased approach allows a licensed digital bank after three years from the commencement of its operations, to submit an application to BNM for the foundational phase to end and for the business limitation to be uplifted. “By the end of the fifth year from the commencement of its operation,” says the policy document, “a licensed digital bank shall comply with all regulatory requirements applicable to an existing licensed bank or licensed Islamic bank and achieve a minimum amount of capital funds of RM300 million unimpaired by losses. The earlier business limitation shall no longer be applicable.”
It is interesting that BNM’s policy document, in a departure from previous policy, allows for a foreign shareholder to hold an aggregate equity interest of more than 50% in a Malaysia-licensed digital bank. The idea is to attract FDI into the banking digitisation services and help build up scale in digital banking operations, which may be limited due to lack of local resources.
“The Bank (BNM) is of the opinion that a 50% foreign shareholding would not be detrimental to the safety and soundness of the proposed licensed digital bank or undermine the stability of the financial system,” says the policy document. This measure is assessed by the availability of resources and expertise contributed by the shareholder that is relevant for delivering the objectives of the licensed digital bank. “For example, the shareholder’s experience in or access to transformative technology in the development and delivery of financial services, as well as the shareholder’s own knowledge/ experience of certain business sectors/markets or access to the requisite knowledge.”