Kakao Bank: World’s most profitable neobank (#21)
Understanding Kakao Bank's strategy to scale and build a high-growth profitable bank
Of all that happened in fintech last decade, hardly anything created the buzz that challenger banks did. Such has been the popularity that roughly 300 challenger banks have popped up around the world today.
And this spotlight has only attracted more scrutiny. Articles by thousands have broken down and studied the digital banking models. Regardless, it is perhaps enough that these banks have forced the lazy incumbents to think.
Nowhere is this more evident than in South Korea. In only three and a half years, Kakao Bank has built an incredible digital bank in Korea, forcing the traditional banks to rethink their strategies. The three statistics below reveal as much.
Launched in July 2017, Kakao Bank has already amassed 13 million+ users. This implies that more than 1 in every 5 South Koreans used Kakao Bank by 2020. The graph below shows that Kakao Bank is the second largest neobank (on user count) in the world.
Today, Kakao Bank is one of the only three full-stack neobanks, i.e. digital banks with banking licenses, in South Korea. The banking license has allowed it to earn through net interest margins (NIM) and not rely on the platform fees-related services. In fact, in the first quarter of the last year, Kakao Bank raked in ~84.4 Bn won (~$78.2 Mn) in net interest margin. To understand the scale, note that this quarterly NIM is ~3.3X the estimated Starling Bank quarterly revenues ($22-24 Mn), based on the July monthly revenue rate, and ~double the overall FY20 revenue of Monzo bank.
Lastly, for those following the challenger banks, a profitable neobank might have seemed an oxymoron for the longest period. But such banks are slowly showing signs of hope and Kakao Bank is leading the pack. Kakao Bank turned profitable in 2019, after only 18 months of operations. Remarkably, it has also consistently shown growth in profits since.
All of these are overwhelming numbers. But unfortunately, there is little written outside South Korea on the successes of Kakao Bank. In that regard, this is an attempt to highlight the strategy and scale of the bank. So, here we go!
KakaoTalk: Building Korea’s biggest platform
In 2010, JB Lee and Kim Bum-soo founded Kakao Inc.
But before this, they had known and worked together for the last five years. JB Lee had founded a company that documented solutions for mobile and web in 2004. In that time, he met Kim Bum-soo, who had quite successfully built Hangman, a giant gaming company that later merged with Naver.
Seeing the potential for the web, Lee and Kim combined to establish IWILAB in 2006. They continued to work on web 2.0 projects for a few years, with only limited success. But in 2009, Korea saw the launch of its first smartphone, which piqued Lee and Kim’s interest. Recognising the opportunity of mobile-first applications early, they pivoted to focus on mobile applications in 2010.
With the pivot, Kakao Inc. was born.
As ever, the team was hardly short on ideas. And shortly after the pivot, the team was divided into three groups to each work on different projects. One of those projects was KakaoTalk.
KakaoTalk, an instant text-messaging application with features incl. free calls, was introduced to the public in March 2010. Within six months, the app had already registered over a million users. Within nine, that number reached five million. The growth was incredible, and with engagement from millions – the founders monetized their platform much like WeChat did in China.
In the next ten years, Kakao would
Merge with Daum Communications – one of the biggest internet companies in the country (2014) to form Kakao Corp.,
Expand its user base to >220 million registered users across Korea, Vietnam, Indonesia, among other South-Asian countries,
Launch over 10 platform and content services, and monetize them to earn ~1.1 Tr won (~$1 Bn) in only Q3, 2020, and
Gain ~45.7 Mn monthly active users (MAUs) by Q3 2020, amounting to ~90% of the South Korean population, to become the most popular application in the country
These are astonishing numbers and achievements by any measure. And throughout, Kakao’s focus on the platform and the mobile-first development has been absolute. This, as I dive deeper into Kakao Bank, would become clear in the next section.
Designing the Future of Banking for South Korea
Traditional banks, in most countries, enjoy oligopolistic market power. And aided with the decade-old processes and heavy balance sheets, there is little incentive to innovate. Not surprisingly then, banking in Korea was also complicated and cumbersome by 2015 for most. This was despite the digital-savvy nature of the population. But with the success of KakaoTalk, Kakao saw the potential of simplifying the banking services. The focus, again, was on mobile.
By 2016, Kakao had already seen Alibaba and Tencent enter financial services in China on the back of their mammoth platforms. Kakao had the platform big and ready, but it saw banking differently. Unlike the technology-led financial services, Kakao wanted finance at the core. It realised that real disruptive innovation would come with full control of their financial products.
With this, the goal was clear. Banking experience had to be made more convenient and mobile-oriented, with Kakao controlling the end-to-end product experience.
This meant that Kakao had to push hard to bring the Korean financial regulator on board to issue new digital bank licenses. Ambitious, but Kakao was able to convince the regulators of the digital bank’s benefits to the public. The enormity of this task is understood from how only three companies (Kakao Bank, K Bank, and Toss) have got the digital bank approval in the South Korea.
With the focus laid down, Kakao Bank collaborated with the EY FSO Consulting team at Seoul to design the customer experience.
I had written earlier on how neobanks differentiate themselves across the five areas of strategy. And at the end of all planning, Kakao Bank was successfully able to differentiate itself across all five.
Identify an under-served market
Offer features that address pain points
Build superior UX
Partnerships to scale
Price for profits
1. Target market: the wiser adults
Most neobanks today appeal to the eccentricity and financial needs of the Gen-Z. Unlike most, Kakao Bank focused on urban 30-to-50 year-olds. As assumed, the urban 30-to-50 year-olds would have better incomes, be more financially educated, and were - thus - more likely to repay the loans. This would allow Kakao Bank to build good asset quality.
These hypotheses proved accurate. The non-performing loan ratio for Kakao Bank’s loans stood at 0.18% in FY 2019, much lower than the commercial banks’ average of 0.55%. The focus on finance as the core of their services is clear here, quite unlike the Chinese counterparts.
Moreover, this target market has served Kakao Bank well since. Even the net promoter score (NPS) for the bank is highest rated by the 40-to-50 year-olds, who have bought into the convenience and quality of these services.
2. Top features: Simplifying transactional banking
Instead of providing complex financial products or financial advisory, Kakao Bank focused on offering simple banking products better than the market. With the costs saved on infrastructure and a lean development process for a mobile-only bank, the bank was able to transfer the cost savings to the customer through fee-free accounts, free interbank transfers, lower loan rates, and lower FX rates. Even for advances, the focus was mainly on unsecured loans like personal loans and overdrafts for the low-to-middle income segment.
The idea was always to ensure activation, before monetization.
To add to the convenience for the users, Kakao Bank ensured that these loans would be disbursed in a matter of minutes. Similarly, for transfers, users could send money directly from their deposits to the friends’ account fee-free through the KakaoTalk platform. And hardly foreign to the neobanks, Kakao Bank offered customers pretty-looking payment cards with the option of fee-free ATM withdrawals.
All these improvements acted to reduce the frictions that customers faced with everyday financial activities. As people floated to Kakao Bank, the bank gradually increased the list of deposit (time-deposits, instalment savings) and loan services (prime credit, secured and unsecured for mid-and-low credit holders, overdrafts, micro, and housing deposit loans), which has allowed Kakao Bank to significantly push up their asset size.
3. Superior User Experience at Every Step
Kakao Bank started by singling out the complexities in the traditional banking experience. Naturally, the goal for the bank had strictly become one to improve the customer experience at every step. This was most apparent in how it approached the account opening process.
An average customer using the mobile apps of traditional banks took 30-40 minutes to open a bank account then. Kakao Bank, with EY, revisited the e-KYC process and designed new systems that allowed the customers to open a bank account in just 7 minutes. They were, extraordinarily, able to do that without breaking any of the regulatory compliances. This was a big differentiator and a testament to their singular focus.
The approach towards UX was visible to customers post account opening as well. Inside the application, customers could change their account names and colours. They could even choose to print their favourite emojis on the payment cards they get.
Such small customizations made the customer experience personalised and added to the delight that customers felt towards the application. Not surprisingly, with this customer-focus, Kakao Bank topped the mobile app Net Promoter Score (NPS) for two years running in South Korea.
4. Partnerships to Scale: KakaoTalk, Trading, and Credit Cards
Challenger banks enter into partnerships to scale their products, usually after noticing some promising traction. But for Kakao Bank, with KakaoTalk spreading the red carpet, they had access to a Day 10 partnership on Day 0. The early association with the instant-messaging platform gave Kakao Bank visibility that would be the end goal for most companies.
This allowed Kakao Bank, aided by its well-thought out customer value proposition, to capture more than 300,000 users within just 24 hours of its launch. The number surpassed a million within a week, 5 million within six months, and 10 million within 2 years.
This partnership also allowed Kakao Bank to reduce its customer acquisition cost to a great degree. However, the competition with K Bank (the only competing digital bank) put pressure on the costs. Regardless, the product strategy and the distribution prowess have combined to keep Kakao Bank ahead of K Bank.
As for partnerships, Kakao Bank is gradually expanding to services that diversify its revenues and enable it to earn from the platform-related service fee. The two most prominent examples are:
Stock account opening services: this service allows users to open a stock trading account in-app with security houses such as NH Investments & Securities and Korea Investments & Securities with the information entered during the Kakao Bank account opening. Launched in Mar ’19, the service became popular as it allowed users to open trading accounts faster. As of June ’20, the platform had enabled more than 2.18 million such accounts – with the growth rate in three digits for the last year.
Credit Card programs: Moreover, Kakao Bank launched four credit card programs in April this year in partnership with KB Kookmin, Shinhan, Samsung, and Citi. Kakao Bank will be responsible for the distribution, while the credit card companies handle the issuing. Besides, the credit cards would come with the Kakao Bank mascot – Ryan, a maneless lion. In Korea, credit cards are the most used payment system. And these four programs will surely push the fees-related revenues higher for the bank.
5. Pricing for Profits
A key insight from the EY-Kakao Bank collaboration was that South Korean consumers are highly price-conscious when choosing a financial service. This was reflected in the early pricing of features incl. interbank transfers, loans, and withdrawals at Kakao.
However, without the large infrastructure costs of traditional banks and the mobile-only focus, Kakao Bank has been able to provide loans at cheaper rates and yet earn a net interest margin of over 2%, flailing all the perceptions of a ‘cheap’ digital bank. By mid-January ’19, Kakao Bank was offering micro loans at ~3%, while the traditional banks asked for 6-19%.
The lower rates and the margins have allowed Kakao Bank to turn up profits only 18 months after its existence. These profits have scaled up with the bank’s operations, with the profits growing seven-fold year-on-year in Q3 ’20. As the platform grows, the profits from fees-based revenues will likely surge to contribute higher to the bottom-line.
The Walled Garden of Kakao Bank: Innovation and Consumer-focus
In only 3.5 years of operations, Kakao Bank has touched >20% of the country’s population. The size of Kakao Bank's loan book is still comparatively small, but the speed of growth and its reach has forced incumbents to take a hard look at themselves. Moreover, seeing the significant improvement in the quality of customer experience with Kakao Bank, all traditional banks have hit the whiteboard and redesigned their mobile applications.
However, the incumbents would struggle to emulate the digital experience and the culture of continuous innovation that Kakao Bank has fostered. This culture of innovation was apparent when the bank built the 26-week deposit product, reducing the terms of the term deposits for higher user convenience.
In only the last year, the bank has come up with two completely new solutions for its users.
The Kakao Bank team has redesigned its user interface with its >10 million customers in mind. The customers can now see all the services and bank accounts they have picked. This leverages the open bank APIs to allow users to access all their bank accounts and other financial services through a single application.
Kakao Bank also launched its Mini service in Oct ‘20, which is a prepaid method specifically for the 14-18 year-old teens. The service allows transfers without opening or connecting to a bank account. Moreover, a minicard is offered for offline payments to teens. The service, much like others, has been a success – surpassing 500,000 subscribers in only a month.
The swiftness in large-scale planning and execution of new products is an asset to Kakao Bank, despite the larger sizes of the traditional banks. But Kakao Bank knows that the biggest challenge might not be from the traditional banks, but the other leaner digital banks.
Fortunately, K Bank is planning to follow a different strategy. With the backing of telecommunications giant - KT, K Bank seeks to incorporate telecom services into its business. Not only that, but it also plans to improve synergies with existing stakeholders such as BC Card, NH Investments & Securities, and Woori Financial Group – all big names in the Korean financial services space.
On the other hand, Toss Bank – with the third banking license - is likely to launch soon. Toss Bank will also divert from Kakao Bank’s tactics, with a focus on financial inclusion through loans to small businesses and people with poor credit histories.
The K Bank and Toss Bank strategies point to possible competition across product subsets for Kakao Bank. However, other digital banks would know better than to compete head-on with Kakao Bank.
Where does Kakao Bank go next?
IPO: With the run of profits, big product launches, and two successful capital raises, the Kakao Bank IPO looks ready to go through this year. Reuters recently broke the news that Credit Suisse and KB Investment & Securities have been picked as lead advisors for the public offering, with the analysts valuing the company around 10 trillion won (~$9.15 Bn). This puts Kakao Bank at a higher valuation than Revolut (last valued at $5.5 Bn in Feb ’20), and only slightly below that of Nubank, which has double the users of Kakao Bank.
Go international: With the goal to become a finance platform similar to the likes of Amazon or Facebook, global expansion is the natural progression for the bank. Initially, Kakao Bank is likely to expand the services to South Asian regions with a sizeable Korean population.
Expansion through partnerships: A super app that goes through the circle of financial services is pitted to enter every fintech domain. Much in the same way, while Kakao Bank offers investment and banking services on the platform today, there are already speculations that it will foray into insurance and wealth management soon.
In all aspects, Kakao Bank is an incredible challenger bank that we should expect to see more and more of. And as Kakao Bank expands outside Korea, Yun Ho-young – the CEO of Kakao Bank – can only wish that the bank finds more voices in the world of financial services.
Other interesting reads on the topic:
On how Kakao Bank cracked the profitability code in two years by Asian Banking and Finance
On the strategy to build a single application for everything by Asia Money
On how Kakao Bank’s innovation comes from ‘observing, detecting trends’ by The Korea Times
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