Murat Erbilen^1]
Lexist Türkiye, Istanbul
m.erbilen@lexist.com.tr

Meysa Yamakoğlu
Lexist Türkiye, Istanbul
m.yamakoglu@lexist.com.tr

Ahmet Arif Harmanşa
Lexist Türkiye, Istanbul
a.harmansa@lexist.com.tr   

The term ‘digital bank’ and its historical development

Banks play a critical role in the financial system and can be classified based on various criteria, including ownership structure (public or private), scope of operations (single-purpose or multi-purpose), number of branches (single-branch or multi-branch), geographical reach (local, regional, national, international or offshore), cost structure (due to maintaining physical headquarters, branches, staff and other infrastructure) and accessibility and convenience (traditional banks may have limited operating hours and require customers to visit physical branches for certain services). Furthermore, beyond these categorisations, banks vary in the distribution channels they employ for the provision of financial services to clientele. These channels, subject to evolutionary shifts, notably in tandem with technological progression, encompass internet banking, phone banking, point of sale (POS), automated teller machines (ATMs) and mobile banking.

Digital banking is a rising phenomenon in the Turkish financial sector. Realising the popularity of banking activities through electronic distribution channels and the significant demand for such services in the market, the Turkish Banking Regulation and Supervision Agency (‘BRSA’) published the Regulation on the Basic Principles of Digital Banks and Service Model Banking in the Official Gazette, dated 29 December 2021 and numbered 31704 (the ‘Regulation’), to regulate the principles of digital banks. The Regulation describes the concept of digital banking and refers to banks that provide banking services through electronic banking distribution channels rather than physical branches.

Legislation regarding digital banks under Turkish law

The primary law governing banking activities in Turkey is Banking Law No 5411 (the 'Law'). Regulations regarding digital banking are included in the Regulation. Pursuant to the Regulation, digital banks can perform all activities that credit institutions can carry out, unless otherwise specified in the Regulation or related sub-regulations. The term credit institution refers to deposit banks and participation banks as defined in the Law.

Article 5 of the Regulation stipulates the restricted activities of digital banks. Article 5/1 states that 'Digital banks' credit customers may consist only of financial consumers and SMEs'.^[2]

Pursuant to Article 5/3 of the Regulation, 'Digital banks cannot organise under any name such as agency, representation, other than the head office and service units connected to the head office, cannot open physical branches, cannot use the service units connected to the head office as physical branches for purposes other than their purpose, and cannot offer safe deposit box and custody services except those to be carried out in the digital environment'.

In addition, the total amount of unsecured cash consumer loans that digital banks can grant to a customer, excluding spending and cash withdrawals made with credit cards and overdraft accounts, cannot exceed four times the customer's declared and confirmed average monthly net income by digital banks. If the average monthly net income of the customer cannot be determined, this amount cannot exceed 10,000 Turkish lira according to Article 5/4 of the Regulation.

Advantages of digital banking in comparison to traditional banking

Reduction of startup costs

As explained above, digital banks, also known as online banks or neobanks, offer significant cost benefits compared to traditional banks due to their efficient operational approach. Unlike traditional banks, by eschewing the need for physical branches and associated overheads, digital banks significantly reduce fixed costs inherent in maintaining brick-and-mortar establishments, such as real estate expenses, staffing requirements and infrastructure maintenance. Because digital banks do not provide services through branches, there is no need to incur many expenses, such as creating numerous branches, hiring necessary staff and procuring space and materials for each branch.

Increase of competition in the financial markets

In connection to the reduction of costs, the existence of digital banks may increase competition in the financial markets by introducing new competitors. Despite the abundance of banks in our country's banking sector, the dominance of a few major banks controlling the pulse of the market has led to significant barriers to entry and exit, resulting in a limited competitive environment.^[3] Digital banking, which can provide a sustainable competitive advantage by reducing costs, can contribute to enhancing competitiveness.^[4] Digital banks can also provide lower operating costs, in addition to lower startup costs compared to traditional banking. As a result, digital banks can offer lower interest rates, fewer or no transaction fees and more advantageous banking products. This assumption translates to more cost-effective and accessible financial services for consumers from both digital banks and traditional banks.

Disadvantages of digital banking in comparison to traditional banking

As at every stage of the banking sector, there are risk factors in digital banking applications.^[5] In this context, the main risks inherent in digital banking activities are examined below:

Security issues

Security risk encompasses factors such as the malicious acquisition of passwords and usernames by third parties, inadequate security measures, security vulnerabilities on websites and lack of sufficient security measures on personal computers.^[6]

Users' personal computers and smartphones, which they use for mobile and internet banking applications, may not be sufficiently secure. Malicious individuals can gain access to these devices in various ways, leading to the theft of bank customers' passwords and other security information, potentially resulting in the seizure of assets held with banks. Because digital banks rely heavily on technology platforms and online infrastructure, this exposes them to risks such as cyberattacks, data breaches and system outages. Customers may be wary of security vulnerabilities or disruption to service.

Identification issues and risk of fraud

Digital bank customers may deny banking transactions made through digital banking applications afterward, claiming that someone else made these transactions without their knowledge. Situations like these can lead to disputes between the bank and customer. For example, a customer who places a stock purchase order online may call the bank two hours later, after the price of the purchased stock drops, to report that his or her password was stolen.^[7] Subsequently, the customer may claim that the transaction was not carried out by him or her. Digital banks may rely on third-party vendors for critical services, such as payment processing, data storage or cybersecurity solutions. A dependence on external providers introduces additional risks related to service reliability, data security and vendor management. Although the establishment of the Financial Crimes Investigation Board (Mali Suçlar Araştırma Kurulu or 'MASAK') and the inclusion of regulations in relevant legislation aim to ensure transaction security during digital banking activities, inherent risks exist in digital banking transactions due to the nature of current technology.

Limited product offerings

Some digital banks may have a narrower range of financial products compared to traditional banks, particularly in areas such as mortgage lending, investment services or specialised business banking products. As explained in detail in the section 'Legislation regarding digital banks under Turkish law' in this article, digital banks are subject to restrictions related to their credit customers, credit limits and so on.

Customer support limitations

While digital banks often provide customer support through online channels, such as live chat, email, phone or at least one physical office, some customers may find these channels less personalised or responsive compared to face-to-face interactions with bank representatives at traditional branches.

Legal framework for customer protection in digital banking

Digital banks must navigate regulatory frameworks governing online financial services, which may vary across jurisdictions and evolve over time. Compliance with regulations related to data privacy, anti-money laundering (AML), and Know Your Customer (KYC) requirements can pose operational challenges and increase regulatory scrutiny. To minimise the disadvantages described above, Turkish law includes numerous protective regulations. The provisions that digital banks' customers can benefit from are regulated in Law No 6502 on the Protection of Consumers, BRSA regulations and other relevant legislation.

According to Article 6/1 of the Regulation, 'Digital banks are required to establish at least one physical office to address customer complaints'. This requirement aims to provide a physical access point for customers to address and resolve any issues they may encounter. In addition, customer rights are regulated in Article 76 of the law, where it states that digital banks have an obligation to establish a system capable of responding to any questions arising from the services they provide and to inform the customer accordingly.

The 76th Article of the Law empowers the BRSA to regulate contracts established through methods enabling the verification of customer identity via information technology or electronic communication devices, and the procedures and principles regarding this are determined by the board. Utilising this authority, the BRSA published the Regulation on Remote Identification Methods to be Used by Banks and the Establishment of Contractual Relationships in Electronic Environment in the Official Gazette, dated 1 April 2021 and numbered 31441. In light of the provision in Article 11/1 of this regulation, banks are responsible for ensuring that solutions used for remote identification minimise the risk of incorrect identification. Additionally, in the case of objections to transactions that entail obligations for the customer or a third party, the burden of proof lies with the bank.

Additionally, the Turkish Banking Association published the Communiqué on the Minimum Matters to be Included in the Form and Content of Contracts to be Signed Between Banks and Individual Customers, and the Procedures and Principles Regarding the Transactions to which the Contracts will Apply, which determines the elements of contracts to be concluded with customers. It is regulated that administrative fines will be imposed on banks that act contrary to these elements.

Lastly, Article 76 of the Law states that the provisions of Law No 6502 on the Protection of Consumers are reserved. Therefore, the Law on the Protection of Consumers and relevant legislation will also be applicable to digital bank customers to the extent appropriate. Differentiating from traditional banking activities, the customers of digital banks can benefit from the relatively more advantageous rights bestowed to consumers that are party to 'distance contracts' as stipulated in Article 48 of Law No 6502.

Conclusion

In the Turkish finance sector, digital banks offer a plethora of advantages, including cost savings, convenience and technological innovation, making them increasingly popular among consumers seeking efficient and accessible banking solutions. However, these advantages come with their own set of drawbacks, such as limited physical presence, security concerns and potential challenges for certain demographics. Moreover, as digital banking continues to evolve, regulations play a pivotal role in safeguarding consumers, ensuring data security, and maintaining the stability and integrity of the financial system. Striking a balance between innovation and regulation is crucial to harnessing the full potential of digital banking while mitigating associated risks. As such, robust regulatory frameworks that promote innovation, protect consumers and foster competition are essential for the sustainable growth and success of digital banks in the modern financial landscape.