Disclaimer: This is an updated version of a blog originally published June 25th 2018. Updated on December 19th 2018.

“How do you build a bank from scratch?”

It’s not a question you’d find yourself asking all too often but it’s one being asked more and more given the rapidly changing financial services landscape in which challenger banks heavily disrupt the status quo.

But how has this come to be?
Our co-founder Huy Nguyen Trieu provided some answers while speaking at the very first Money20/20 Asia event. Below, we’ll recap the main points covered in his talk and provide a couple bonus options to reinforce your learning.

An environment ripe for disruption

As we noted, the financial services landscape is swiftly changing; but this is more to do with overall macroeconomic changes rather than some aspect specific to finance. These changes currently provide fertile ground for the rise of new technology-enabled banking and can be summed up in three points:

1. IT Cost – the cost of IT has plummeted over the last few years. 20 years ago you would spend the first $2m that you made on technology (Microsystems, Oracle database, software etc.) Now you only need to spend $100 a month on cloud computing for the same technology infrastructure!
2. Consumer habits – consumer behaviour has changed over the past ten years.
3. Regulation – Today’s regulation makes it incredibly easy to launch a new bank in places like the UK, and its expanding in other countries like Singapore and Hong Kong!

A conclusion to be drawn from this: the barrier to entry in banking has gone down significantly over the last 20 years, as building banks becomes more accessible.

Two decades in the making

To illustrate the point, 20 years ago a new digital bank, Zebank received 200 million dollars in investment. It took them 2 years to retain 100,000 clients. What’s changed between then and now? You may have guessed it, now there are banks doing the same thing in the same amount of time but for 20 times less money!
We are seeing the rise of new banks everywhere in the world – in the U.S, Asia, Africa and in Europe. The question that arises is ‘why do we see so many new banks in Europe, specifically in U.K compared to the rest of the world? The answer, regulation. The UK has a two-stage licensing process that makes it much easier and much cheaper for new startups to enter into the banking world, and consequently – there are numerous more attempts at building banks.
Another noticeable trend across most countries is the rise of specialized banking. Until now we have enjoyed full-service banks, but now banks are able to cater to a very specialized target audience such as children, millennials, SMEs and the unbanked, the latter especially so in developing countries. It’s a trend that’s grown stronger as the cost of banking declines.

So how do we build a bank from scratch?

First off, it’s important to make a distinction between the 2 types of banks which can be created in the age of Fintech. A ‘full bank’ – one that replicates the services of a traditional bank (i.e. has a full banking license) and a Neo Bank – one that looks like a bank but has distinctly different characteristics. 
Moreover, banking can seem inaccessibly confusing but let us simplify its methods through the following: i) where you’re spending your money and ii) how much money you’re making:

1. Expense – you’ll spend your money on the operation and regulatory side first
2. Revenue – You’ll make money by having clients but that depends on your revenue model.

Now, how do the 2 types of banks stack up on both sides of the equation? 

Expenses

Full Banks 

On the expense side – you need to ask yourself ‘how much does it cost to launch a bank’ –regulatory costs are about $20m (part of that money goes to regulatory submission and a lot of that would be capital) also operation cost about $40m (this is needed to create your own technological infrastructure.) In total It would cost you about $60m to launch your digital bank. 
This is much cheaper than it would’ve been 20 years ago when launching a bank would cost around $200m.

Neo Banks

On the surface, Neo banks like Revolut may seem like banks, however, they are different in that they do not possess a banking licence but an e-money licence instead. 
This, in turn, reflects directly on the cost of setting up the bank. Regulations cost is much less, at $1m dollars and operations cost are approximately 8x cheaper at $5m. The reason for this is because neo-banks are much more narrow in terms of service i.e. specialised, in total it sums up to $6m to start a neo-bank.

Revenue 

One of the main questions however that new banks are facing is one of the revenue models and how to make money. Although the cost part is already well known, the acquisition of money has remained a mystery. This is due to the fact that new banks stray from traditional banking as traditional banking would make money from two different sources of revenue:

• 2/3 – 65% interest income difference from lending and borrowing
• 1/3 – 35% fees (transaction fees)

A lot of banks start with the transactional fees and leave the interest income untouched but the question is whether you can create a large business like that. Another question that arises is what the banks will do about the data as a lot of ‘new’ banks are trying to monetize data. 
Yet the reality is that few new financial startups have been able to successfully monetise data. Credit Karma is a rare exception, its growth has led it to become one of the biggest financial companies in terms of users in the US. And so in terms of generating revenue, new challenger banks still have a long way to go before they can compete with the traditional marketplace. 

Final remarks

So where does this leave us in terms of our initial question, “How do you build a bank from scratch?”
In short, understanding the overarching framework or environment in which modern banking is taking shape will give you the right foundation to build a bank that takes advantage of plummeting costs, favourable regulation (especially in the UK) and caters to changing consumer habits.
Below is a video of Huy himself explaining this finer points in more detail. If you’re interested in gaining a comprehensive understanding of Fintech, including how financial services and fintech careers are affected by the rise of intelligent technologies, we recommend two certified courses:

• CFTE’s Fintech Foundation course, Around Fintech in 8 Hours.
• AI in Finance – jointly developed by CFTE and Ngee Ann Polytechnic.

For the latest news and trends in the Fintech world, feel free to subscribe to our newsletter after the jump!


Disclaimer: This is an updated version of a blog originally published June 25th 2018. Updated on December 19th 2018.