KUALA LUMPUR: Digital banking license winners have bright prospects and are not major threats, and can co-exist quite harmoniously with their conventional banking counterparts.

Hong Leong Investment Bank Bhd (HLIB Research) opined that the sector's risk-reward profile is still skewed to the upside as valuations are undemanding, and the research firm is only at the cusp of an Overnight Policy Rate (OPR) hike upcycle with economic recovery, which benefits banks.

To recap, Bank Negara Malaysia (BNM) had on last Friday announced the five successful applicants for digital banking licenses.

They are a consortium of Boost Holdings and RHB Bank, a consortium of GXS Bank and Kuok Brothers, and a consortium of SEA Ltd and YTL.

Digital Capital, a consortium of Aeon Financial, Aeon Credit Service, and MoneyLion Inc and a consortium of KAF Investment Bank.

"We gathered they will have to undergo a period of operational readiness that BNM will validate through an audit before commencing operations. This process may take between 12-24 months," the bank-backed research firm said in a note today.

Further, HLIB Research noticed that digital banks in China and Korea took around 1-2 years from inception to turn profitable.

Even after 4-6 years of operations, both loans and deposits growth remained phenomenal at 30-50 per cent annually.

"That said, Chinese and Korean digital banks are still only fetching less than 3 per cent market share in their respective

domestic system loans and deposits.

"As for net interest margin (NIM) experience, the gap between Chinese digital versus traditional banks is less than 2ppt (where the former is higher), while in Korea, a similar NIM profile was observed between the two.

"This shows that product pricing is competitive, and it is not easy to dethrone traditional banks as leading financial institutions.

"Putting aside the impact of any monetary policy actions, we find that traditional Chinese and Korean banks' loans and deposits growth trajectory stayed robust while their NIMs held steady," HLIB Research said.

Looking at the trends in China and Korea, HLIB Research believes that the five digital banking license winners' primary existence is to address market gaps in the underserved and unserved segments, which are not a playground for classical banks.

Secondly, the assets of the five combined digital banking licensees (RM15 billion) could potentially shave away only less than one per cent share of system loans, which is insignificant.

"We estimate every one per cent slowdown in loans growth could reduce sector earnings by 0.5 per cent.

"Thirdly, conventional banks have already equipped themselves ahead of time by embarking on digital transformation projects to shift away from outdated business paradigms.

"Given archaic banks' bigger balance sheet, they have more budget headroom on an absolute monetary basis to spend and innovate versus digital banks," it said.

HLIB Research maintains Overweight for the sector as the firm believes the sector's risk-reward profile is skewed to the upside as valuations are undemanding and are only at the cusp of an OPR hike upcycle with economic recovery, which benefits banks.

"As such, we remain bullish and employ a rather broad stock buying strategy in the first half (1H) of 2022.

For large-sized banks, HLIB Research likes Maybank Group Bhd with a target price of RM9.40 for its strong dividend yield and Public Bank Bhd with a target price of RM4.80) for its large potential headroom to perform management provision overlay writebacks.

For mid-sized banks, RHB Banking Group, with a target price of RM7.00) is favoured for its high common equity tier 1 (CET1) ratio and attractive price tag.

As for small-sized banks, Bank Islam Malaysia Bhd with a target price of RM3.45 and Affin Bank Bhd with a target price of RM2.35) are preferred.

"We like the former for its positive structural growth drivers and better asset quality while the latter has special dividends potential and strong financial metrics," HLIB Research said.