FINTECH | PH: On the verge of a digital banking revolution

by Guillaume de Gantès, Hernan Gerson, and Kristine Romano

As regulators encourage new players to enter the digital financial services sector, firms that take the initiative can gain an early advantage in one of the world’s largest greenfield markets.

The Philippines is among the fastest-growing economies in Southeast Asia, yet the wholesale and corporate focus of large traditional banks has left a vast potential customer base underserved. While the introduction of digital technologies has driven gains in financial access in emerging markets and developing economies worldwide, incumbent banks in the Philippines have underinvested in digital offerings. Philippine banks devote less than 10 percent of their revenues to IT, compared with an average of about 15 percent among incumbent banks elsewhere in Asia–Pacific, and digital channels account for just 5 to 15 percent of their revenue, well below the average of 25 percent for their peers in Asian emerging markets.

Meanwhile, existing Philippine fintechs concentrate almost exclusively on payments, and infrastructure constraints limit their reach. The result is a widening gap between the country’s enormous underbanked population and the expanding range of innovative financial technologies lying just beyond its borders. The banking penetration rate remains among the lowest in the region, and traditional financial institutions focus heavily on commercial lending, leaving a rapidly growing, increasingly affluent, and digitally savvy population with little access to financial services that meet their needs.

This situation, however, is changing rapidly. Recognizing that fostering fintech innovation will be vital to achieve their ambitious goals for financial inclusion, regulators are laying the necessary groundwork for digital financial services and digital-first business models. The sectoral regulator has recently introduced new digital banking licenses, created a real-time payments system, and established a standardized QR network. Digital start-ups are proliferating; traditional banks are investing in their digital offerings; and foreign banks and fintech service providers are expanding their presence in the Philippines. Two domestic payments services, GCash and Maya, are operating at scale, and global players are already jockeying for position in a rapidly evolving and highly promising market for digital financial services. In this dynamic environment, new entrants that move swiftly and offer products tailored to the needs of underbanked businesses and consumers,both in urban and rural areas, will be able to establish strong market positions, while latecomers will struggle to stand out in an increasingly crowded field.

Consumer demand is intensifying

Converging economic, demographic, and technological trends have created a burgeoning but still largely unmet demand for digital financial services in the Philippines. GDP growth is forecast to average 6-7 percent per year over the medium term, and per capita GDP is expected to grow by about 55 percent within the next eight years. Decades of economic expansion have enabled thousands of underprivileged Filipinos to join the ranks of the middle class, which has begun to enjoy the benefits of its newfound purchasing power. Three-quarters of the population has internet access, and mobile penetration is nearly universal. The Philippines has one of the fastest population growth rates worldwide, and the bankable population is projected to rise from 65 million in 2022 to 85 million by 2030—a 30 percent increase. The rise of a young, tech-savvy consumer base is driving a surge in demand for innovative financial services, leading to the rapid expansion of mobile payments platforms ranging from e-wallets to the digital apps of incumbent banks. Meanwhile, other technology-driven financial subsectors have only begun to emerge.

Amid mounting demand for financial services, banking revenue is expanding at a compound annual growth rate of 9 to 10 percent, and banking revenue pools are expected to triple by 2030. However, the country’s banking penetration rate is just 56 percent, remarkably low by the standards of emerging markets. Traditional banks remain focused on wholesale banking and have been slow to reach new customers outside their existing client base. Rural areas are home to nearly half the population, yet rural households are especially underserved, and many have little or no access to brick-and-mortar banking infrastructure.

Corporations receive 76 percent of all loans, one of the largest shares worldwide, while small and medium-size enterprises (SMEs) continue to face binding credit constraints. The Philippines has an estimated 15 million informal entrepreneurs and self-employed workers—a massive pool of would-be borrowers with little access to traditional finance. Meanwhile, retail lending is heavily concentrated in a narrow band of wealthy households. This unbalanced distribution of existing loans—combined with a rapidly growing adult population, continuous broad-based gains in household income, ongoing regulatory efforts to promote financial inclusion, and the introduction of new digital technologies—makes retail lending especially prone to disruption and accelerated growth.

The public’s limited information about the banking system is a major challenge. Statutory balance requirements have long since been eliminated, and many banks offer accounts with no minimum balance, yet 45 percent of unbanked Filipinos believe balance requirements would prevent them from opening an account. Another 40 percent of unbanked Filipinos say their main reason for not opening a bank account is their belief that they lack adequate documentation, but this challenge is likely exaggerated in the public imagination. While ID coverage is not universal, and the onboarding procedures of traditional banks are often needlessly cumbersome, the country’s nascent mobile-banking sub sector already offers basic accounts that can be opened with nothing more than an ID card and a selfie, as well as restricted accounts that require only a phone number. To further ease documentary requirements, the government recently launched the SIM Registration Act (SRA), linking cellular SIM cards with verified users. The remaining 15 percent of unbanked Filipinos point to a lack of trust in financial institutions as their chief reason for not opening an account. This attitude may prove to be the most enduring challenge to the expansion of retail banking, especially among SMEs and lower-income households.

More players are poised to enter

In other emerging markets, fintech firms and nonbank financial service providers have stepped into the gap, offering innovative solutions designed to meet the needs of small-scale borrowers with limited financial documentation and low levels of trust in the banking system. In the Philippines, however, a combination of weak information infrastructure and limited risk appetite has discouraged existing banks from courting new market segments, especially thin-file customers with small ticket sizes, given the perceived high risk and low profitability of the segment. Meanwhile, the existing fintech sector has grown almost exclusively on payments and currently commands a negligible share of the lending market.

Domestic banks have also been unable to leverage opportunities presented by the unique features of the Philippine economy. Each year, an average of about $30.5 billion in remittances (about 10 percent of GDP) flows into the Philippines through wire-transfer services and traditional interbank networks, with all the associated transaction records and fees, yet traditional banks have not systematically incorporated remittance income into their lending decisions. Remittances play an especially vital economic role in rural areas, where households are least likely to have access to bank accounts, credit histories, and collateral. Domestic payment services such as GCash and Maya are explicitly targeting remittance transactions, disrupting the established model of brick-and-mortar service providers.

Recognizing the untapped potential of digital financial services, the government recently launched a reform program designed to increase competition in traditional banking while facilitating the growth of fintech alternatives. The centerpiece of this effort is the central bank’s aggressive target of 70 percent banking penetration by 2030. To attract foreign entrants, the authorities have relaxed limits on foreign ownership, national hiring quotas, and data localization requirements. The bank-licensing process has been streamlined. Foreign firms (with a minority local partner) can acquire small rural banks, and foreign banks can establish wholly owned subsidiaries. The alignment of Philippine regulations with International Financial Reporting Standards (IFRS) has sharply lowered compliance costs for established international financial firms. The introduction of digital banking licenses has further reduced the country’s already-low minimum capital requirements and allowed fully foreign entities to obtain a banking license. For retail customers, opening the simplest accounts now requires only a phone number or an ID card. The central bank’s unified QR code payments infrastructure (QRPh) has cut person-to-merchant (P2M) transaction costs while further expanding the reach of digital payments systems, and the introduction of InstaPay and PesoNet is enabling at-scale transactions via electronic bank transfers.

The challenge facing incumbents

Beyond their immediate impact on the business climate, these reforms indicate a credible governmental commitment to intensifying competition in financial services and enabling the technological disruption of the banking sector. Unprotected from innovative competitors, incumbent banks will need to adapt quickly or risk a permanent loss of market share. The traditional banking sector has already proven vulnerable to digital innovation. Despite their limited scope, digital financial service providers performed especially well during the COVID-19 pandemic, creating more shareholder value than the entire banking sector. Between January 2021 and January 2023, the market value of the country’s traditional banks increased by $2.2 billion, while the total market value of the top three fintech firms rose by $3.0 billion.

Established banks have been slow to embrace the more transformative aspects of digital finance. To date, their efforts have largely focused on creating mobile apps for existing customers and digitizing legacy processes. However, mounting pressure from fintech firms is spurring innovation in the traditional banking sector. For example, BPI, one of the country’s largest banks, recently launched the Vybe e-wallet on its mobile app. Vybe offers many of the same services as GCash and Maya, and its uptake by a traditional bank illustrates the efforts of incumbent financial institutions to compete with fintech service providers in their native market segments. Meanwhile, UnionBank has begun offering fully digital financial services to underbanked consumers via its UnionDigital Bank proposition.

While competition in digital financial services is clearly intensifying, dominant players have yet to emerge outside the mobile-payments subsector. Six digital banks have recently launched operations in the Philippines, but none are currently lending at scale. Some of the most dynamic fintech firms, including GCash and Maya, are payments providers that have recently expanded into lending, investment, insurance, and marketplace services. Maya has obtained a dedicated digital banking license, while GCash distributes consumer-finance loans both from itself and from third parties. Though their customer bases together encompass more than half the Philippine population, these digital pure plays are capturing only a small fraction of the market for digital financial services. To reach their potential, fintechs and digital banks must address their own unique challenges, including transforming operations and improving profitability to sustain growth momentum.

As the Philippine fintech sector develops, an experienced international firm with market-tested products could take a strong position in high-value segments while facing far less resistance from entrenched competitors than it would in a more mature environment. New entrants equipped with an understanding of the local economic and regulatory context can swiftly establish a consumer base and begin building brand recognition, while firms that lack on-the-ground knowledge may encounter unexpected technical, structural, and administrative obstacles despite the improving business climate. Partnering with an established domestic player can provide vital information on local market conditions, and such partnerships can offer incumbents a chance to expand their offerings rapidly while leveraging the experience of an international counterpart. The fintech landscape also offers considerable scope for unilateral expansion by existing banks that are willing to move beyond their existing customer base, embrace new service models, and invest in their capacity for innovation. The underserved rural sector is well suited to digital-first or hybrid offerings, and recent changes to onboarding requirements and agent-banking rules are designed to enable digital service providers to maximize the impact of the country’s limited rural banking infrastructure.

While the Philippines presents highly attractive opportunities for expansion, the way foreign firms and existing Filipino conglomerates choose to enter the fintech sector will have a major impact on their growth and competitiveness. Universal banking licenses are available to fully foreign-owned banks that are established, reputable, financially sound, and willing to share banking technology. Domestic and foreign banks no longer require separate licenses and are subject to the same minimum capital requirement of $55 million to obtain a universal banking license. In 2020, the government approved the creation of a digital banking license that allows for full foreign ownership and entails a capital requirement of just $19 million, provided that the bank maintains a principal or headquarters in the Philippines. Six digital banks are licensed under this dedicated regime, but no new applications will be accepted until 2024. Expert advice from a partner with detailed knowledge of the application process will be a critical asset for any firm that wishes to obtain a license when the process reopens.

Universal banking licenses and dedicated digital licenses each confer specific advantages, but the simplest way for a foreign player to access the Philippine market may be to acquire a small rural bank and repurpose it for digital banking. Over 400 rural banks are eligible. Many have already been acquired for less than $5 million—a fraction of the cost in comparable markets—and their minimum paid-up capital ranges from $1 million to $3.6 million depending on the number of branches. This approach will be especially attractive in the near term, given the relatively long wait time for a universal banking license and the suspended application process for digital licenses. Seabank Philippines offers a prime example of this strategy in action. In October 2020, Seabank acquired a majority stake in Banco Laguna Inc, a small rural bank, and in April 2021, it obtained an Electronic Products and Financial Services (EPFS) Type A License, which enabled it to launch its digital-first proposition nationwide.

Limited information infrastructure remains a serious challenge. The narrow coverage of a unique national ID complicates know-your-customer (KYC) compliance, and the nascent credit bureau database offers only a limited appraisal of prospective borrowers’ creditworthiness. The underdevelopment of traditional financial systems presents additional obstacles, with low rates of point-of-sale penetration (0.1 percent) and credit card uptake (9 percent). QR-based P2M and e-wallets appear to be leapfrogging credit card networks, but their coverage remains limited. Internet penetration is relatively high at 73 percent, but still far from universal.

The opportunities presented by the vast greenfield market for digital finance in the Philippines far outweigh the risks, but a keen awareness of the challenges facing fintech service providers will offer a critical advantage. Navigating the rapidly shifting landscape of digital finance in the Philippines requires understanding the sector’s structural limitations, evolving regulatory context, relationship to the national economy, and position within the global fintech ecosystem. An experienced partner with a deep understanding of the local context can enable new entrants to outmaneuver foreign and domestic competitors and position themselves to enjoy decades of growth in a dynamic emerging economy.

Guillaume de Gantès is a senior partner in McKinsey’s ASO offices where Hernan Gerson is an associate partner, and Kristine Romano is a partner in the Manila office. The authors wish to thank Aaron Ong for his contributions to this article.

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