Financial services are heavily regulated in a large variety of ways. For example, the scope of activities that banks can undertake is limited, there are capital requirements to lower the risk, interest rate caps to protect customers and reporting requirements for supervision and transparency, amongst many others. All this regulation aims to protect the stability of the economy, protect the position of the customer and achieve desired societal outcomes.
Before being able to provide financial services, therefore, one typically needs a financial license in some form. Licenses differ in their scope of permitted activities and requirements on the organization. These licenses are typically issued by local regulators such as central banks and financial market supervisors (i.e. SEC, ECB, AFM etc.), together with generic governmental bodies.
Regulatory frameworks and licensing requirements vary widely across jurisdictions and types of financial services. Generally, licensing can be grouped under (full, traditional) banking licenses and (partial, lighter, modern) fintech licenses.
The Full Banking License
A full banking license allows a financial institution to accept customer deposits and issue loans using customer funds. A banking license, including the many differentiations there off, allows for the broadest scope of services, but also is the most heavily regulated. Note that only institutions with a banking license may call themselves a ‘bank’
A banking license is issued by the competent regulatory authority, typically the central bank. The relevant authority will depend on the geographical location of incorporation and also the geographical markets you operate in. These can include supranational regulators, such as the European Central Bank (ECB) in Europe or the Federal Reserve (Fed) in the United States, as well as local national bank regulators such as the Saudi Arabian Monetary Authority or Hong Kong Monetary Authority (HKMA).
A banking license application can be rather complex and costly option for new digital banks. The benefit is that it allows for the broadest range of banking services to be provided, but this comes with higher regulatory and compliance obligations and often higher capital requirements. The application process for a banking license is also very lengthy and can take up to 15 months depending on the jurisdiction. In general, a minimum cost of €2M+ is needed to enter the application process, with ongoing additional costs needed to run the company.
The Fintech License
The rise of fintech in recent years has also brought a new wave of banking regulation. Many jurisdictions around the world are embracing innovation and facilitating the entrance of new digital players into their financial systems with lighted regulation, as a way of modernizing their financial services landscape and enhancing competition.
As part of this regulatory approach, new types of financial service licenses were created. These are typically light versions of full banking licenses designed to accommodate digital business models, allowing these institutions to offer banking-like services but at a lower regulatory and compliance threshold. Often these are combined with regulatory sandboxes, which provide testing grounds for new business models.
Fintech Licenses or else called bespoke digital banking licenses have seen popularity, especially across the Asia Pacific region with many jurisdictions introducing their own licensing frameworks. The People’s Bank of China was one of the first regulatory bodies to issue five internet-only banking licenses after which several countries followed the example. By now, Hong Kong, South Korea and Taiwan all have issued dedicated fintech licenses.
Other jurisdictions such as the Singapore, Australia or Malaysia practice a phased or sequenced licensing approach where the applicant has at first limited activities to offer to the market and typically lower capital requirements before transitioning to the equivalent of a fully licensed bank. During this phase which usually lasts for two to five years, authorities are monitoring the company’s progress in reaching full compliance with the regulatory framework. For Instance, Malaysia, which just recently reached its deadline for the license applications even saw 29 contenders for a maximum of five licenses.
In Europe, the license that comes closest to its Eastern counterpart is the E-money license (also called an EMI, electronic money institution or sometimes the ‘e-wallet’ license), which supports payment services such as transfers and card transactions by means of a digital account or digital wallet, where the customer can hold funds in the account. An EMI license enables holders to provide the same customer banking experience for daily payments as a full banking license.
However, there are also some limitations to an EMI license. Firstly, it does not allow for credit issuance, often an important revenue stream for banks. Secondly, an EMI cannot hold custody of the customer funds, instead, it must use a partner bank. Thirdly, an EMI may face limitations such as the maximum amount customers can hold in their e-wallets and also certain transaction limits, depending on the level of due diligence/KYC conducted on the client.
An EMI license can be a cost-effective option for a new digital bank. The application process usually takes 6-12 months and legal fees range from €75,000-€150,000 for the regulatory license application, with the average total cost to set up the whole organization varying from €1-€2 million.
Lastly, some jurisdictions such as Brazil or South Africa still treat digital banks equally as plausible banks that are leveraging on technology and digital transformation. Instead of creating a tailored licensing procedure, they license digital banks under their existing full banking license regimes.
The Partnership Model
The above describes the general regulatory framework for digital banks. However, start-ups and other organizations do not necessarily need to hold these licenses themselves; they also have the option to operate white label under the auspices of a licensed financial institution. This, allows start-ups to establish themselves more easily and operate under a third party until they have reached sufficient scale to obtain their own licensing.
There are many players in the market that offer licensed financial services, for example for BIN sponsorship for payment cards, account management, and loan issuance. In fact, many neobanks operate a white label debit card and e-wallet or offer credit-issuing delivered by third-party institutions. Depending on the commercial agreement and type of service, these typically require an initial set-up fee together with a monthly fee and/or fee per use.
The benefit of the partnership model is that it allows start-ups to circumvent the lengthy and complex license application process and operate in a cost-efficient way before they have achieved scale. The downside is the dependence on the third party, with less flexibility and also less control and insight into money flows.
It should be noted that no matter the license applied to, new upcoming banks must still follow basic regulations such as AML/CFT and customer protection obligations.
How to choose the right license for your bank
The choice of regulatory licensing ultimately depends on the value proposition and business model. Therefore, it is vital to have these inputs already in place before deciding on what type of license is the right one for you.
We already highlighted that a first starting point on getting a broader idea of which licenses could be relevant is dependent on the geographical location of incorporation and also the geographical markets you want to operate in. Nonetheless, there are certain other aspects that should be considered in order to identify the best suitable license for your case.
Most importantly, scale and timing are key metrics that will determine the business case for whether to work under a partnership model or to obtain your own licensing. Your pre-defined MVP, product roadmap and desired time to market are all inputs that should give you insights on requirements you have towards the license and the application procedure. For instance, a bank aiming for a quick market launch and limited capital is best advised to lean towards quicker and more cost-efficient licensing approaches such as a fintech license or a white-label license under a partner. On the other hand, a bank that wants to launch with a more comprehensive product suite and capabilities probably are better served by going for a full banking license either by themselves or as well via a partner.
However, even when deciding for an initially quicker licensing scenario such as going for an EMI license, it is still possible to turn towards a full banking license later in your strategic roadmap. In the end, choosing the right license is just one step in the journey.
For a more detailed overview of what it takes to launch and scale a digital bank, we recommend for you to look into our exclusive guide How to successfully build digital bank on which this post was based.
How Fincog can help
Regulatory initiatives are altering the state of banking across the world at a rapid pace. Building on our experience in guiding licensing applications around the world, we make sure that our clients firstly make the right choices under which license to set-up their new venture, but also guide them on their way to successfully obtain their license in the timeliest manner. Our regulatory licensing experts have extensive experience working on licensing applications and many also bring a strong background in compliance and risk management. Additionally, our team of global consultants and subject matter experts exhibits vast experience across financial services and IT, combining strategic thinking with business acumen to support you end-to-end in designing, building and scaling digital banks.
Fincog is a leading strategy consultancy specialized in fintech and banking. We enable our clients with end-to-end consulting support in designing, building and scaling digital banks as well as transforming legacy organizations.