Following the success of pioneering digital banking services by Bank BTPN with Jenius and Bank DBS with Digibank, emerging banks such as Bank Neo Commerce and Bank Jago are jumping on the bandwagon.

With the Roadmap for Indonesia Digital 2021-2024 drafted by the Communications and Information Ministry, there is no indication of this trend declining anytime soon. Instead, with digital banks projected to be widely available, more people will be able to access digital banking services in the future, which will include obtaining financing for small and medium enterprises as well as consumer credit.

While promoting financial inclusivity, these services are notoriously provided by rural banks.

Rural banks originally developed in remote areas to serve the needs of unreached population segments unable to obtain financing from commercial banks, while taking into account the characteristics of local business activities.

With the concept of the digital branch, digital banking is expected to cover all of Indonesia even without a physical presence. Consequently, the services provided by rural banks may eventually be taken over by commercial banks.

The question then remains, where does the bank digitalization trend leave rural banks? What chances do they stand to adapt to such an advancement?

Legally, the Financial Services Authority (OJK) also encourages rural banks to go electronic. Through OJK Regulation No. 12/POJK.03/2016, rural banks with a certain amount of core capital may perform electronic banking services, such as through phone banking, SMS banking, mobile banking and internet banking.

However, OJK Regulation No. 12/POJK.03/2018 distinguishes between electronic banking and digital banking services, in which electronic banking only serves as a delivery channel, while digital banking is a digital branch of a bank. Therefore, in competing with the existing and emerging digital banks, there are obstacles and challenges rural banks need to overcome.

The first obstacle is related to the lack of underlying regulations for rural banks to conduct digital banking activities. OJK Regulation No. 12/POJK.03/2018 as the prevailing regulation concerning the provision for commercial banks to conduct digital banking does not include rural banks in its scope of subject. This implies the omission of rural banks in digital banking regulations, which makes it unlikely they will be facilitated in going digital – especially in terms of capitalization.

Currently, the regulation governing digital banks is under preparation by the OJK and is set to be released by mid-2021. Among other things, provisions to be included in the regulation include the minimum capitalization of digital bank, which stands at Rp 10 trillion (US$710 million) for a newly established digital bank company and/or Rp 3 trillion for a conventional bank that is conversed into a digital bank. While it is uncertain whether this new regulation will apply to rural banks, it is quite certain that rural banks will struggle to comply with this minimum capital requirement alone.

Subsequent to low capitalization, a lack of ability in developing technological infrastructure is inevitable. Meanwhile, developing technological infrastructure is an integral part of digital banking operations. Existing banks that offer digital banking services unsparingly allocate Rp 500 billion or up to Rp 1.5 trillion of investment to the development of digital banking infrastructure.

Digital authentication and verification of customer data, for instance, is one of the key features of digital banking. As mandated by OJK Regulation No. 12/POJK.01/2017 as well as OJK Regulation No. 12/POJK.03/2018, to provide digital banking services, banks are required to own adequate information technology infrastructure and the management thereof, including to operate electronic infrastructure for performing digital verification. The fact that rural banks still rely on manual verification accentuates their outdated method in the digital era, which is less convenient during the pandemic.

Other than authentication and verification processes, digital banks also depend heavily on technology for governance, data security, fraud and cybercrime resolution and for the ecosystem that connects to other platforms.

Aside from digital banks, financial technology (fintech) companies are also growing rapidly. Simultaneously, their technological infrastructure is no less competitive than that of digital banks, specifically in terms of machine learning and their ability to perform operations through digital means.

Like rural banks, most fintech customers are unreached and unbanked people, but they are skilled enough to utilize online digital financing. Hence, the possible method for rural banks to survive on the brink of digitalization is to team up with fintech.

Online financing companies, for instance, open up the possibility for rural banks to cooperate, specifically through channelling scheme. Through such cooperation, rural banks can reach fintech’s wide user base to channel loans while, at the same time, the collection of customer’s data, authentication and verification, credit scoring and other operations are performed digitally by the fintech companies. That way, rural banks and fintech create mutually beneficial cooperation as well as convenience for users.

In conclusion, digitalization is intended to increase financial inclusivity in society. Hence, the presence of digital banks does not necessarily threaten rural banks. With the right strategic cooperation, rural banks can coexist with and face the “Goliath” of digital banks, and ultimately serve more small and medium enterprises, farmers and other small-scale customers.

 ***

Erick Sanjaya Perkasa and Johanna Devi are legal specialists at a leading fintech group in Indonesia. The views expressed herein are personal.

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