DIGITAL BANKING BUSINESS TREND AND COMPARABLE VALUATION IN INDONESIA

INTRODUCTION

Rapid technological development has led to the creation of digital banking, which is altering Indonesia's
traditional banking business. Due of its potential impact on the economy, the financial sector, and
society, academics and practitioners are becoming increasingly interested in this issue. By conducting a
comparative digital banking valuation, this study intends to provide light on the digital banking business
trend in Indonesia.

In recent years, digital banking in Indonesia has expanded rapidly because to the increasing penetration
of smartphones and internet connectivity, as well as a legislative climate that is conducive to its
development. Digital banking is regarded as a significant driver for financial inclusion in Indonesia, as it
gives unbanked and underbanked parts of the population access to financial services. However, the
digital banking market in Indonesia is still in its infancy, and research on the valuation and performance
of digital banks in Indonesia is lacking.

This study's primary purpose is to examine the valuation of digital banking companies in Indonesia.
Provide a full overview of the digital banking business in Indonesia, including its current situation, future
growth possibilities, and critical success criteria, in this study. By attaining these goals, the research can
assist to the creation of a more precise and trustworthy technique for valuing digital banking enterprises.

The purpose of this study is to answer two research questions. RQ1: examine the digital banking trend in
Indonesia; RQ2: study the financial performance of chosen digital banks in Indonesia; and estimate the
valuation of selected digital banks using an equity valuation model.

This study has both theoretical and practical implications. Theoretically, this study advances knowledge
of the digital banking market in Indonesia by shedding light on the valuation and financial performance
of digital banks in Indonesia. This study provides investors, regulators, and policymakers with vital
information regarding the valuation and performance of digital banks in Indonesia, which can impact
their investment and regulatory decisions.

The research will use a mixed-methodologies approach that integrates quantitative and qualitative data
analysis methods. The data would be obtained from the financial statements of chosen digital banks in
Indonesia and from public sources. Using quantitative analysis tools, this study employs equity valuation
approaches such as discounted cash flow (DCF) to assess the valuation of digital banks in Indonesia. The
qualitative analysis will consist of interviews with industry experts and key stakeholders in order to
acquire a deeper knowledge of the digital banking business in Indonesia.

The essential assumptions behind this analysis are that the financial statements of chosen digital banks
in Indonesia are trustworthy and appropriately reflect their financial performance. In addition, it is
assumed that the digital banks picked in Indonesia are representative of the digital banking business in
Indonesia.

This study is limited by the small sample size of selected digital banks in Indonesia, which may restrict
the generalizability of the findings to the broader digital banking market in Indonesia. Moreover, the
study depends on publicly available data, which may not be exhaustive or up-to-date. This study does
not include other aspects such as consumer satisfaction, brand awareness, or technical innovation.

LITERATURE REVIEW

Digital Banking

Digital banking has rapidly evolved in recent years, and its potential to transform the financial services
industry continues to grow. The report "Digital Banking 2025: Unlocking the Full Potential of Mobile
Financial Services" by Harvard Business Review Analytic Services highlights the key trends and future of
digital banking.

The report predicts that by 2025, digital banking will be the primary banking channel, with mobile
devices serving as the central platform for accessing financial services. It emphasizes the importance of
data analytics in digital banking, which enables banks to provide personalized services, optimize their
operations, and mitigate risks.

The report also discusses the potential for digital banking to promote financial inclusion, particularly in
emerging markets. It highlights several successful digital banking initiatives that have enabled the
delivery of financial services to previously unbanked populations.

Digital banking is an electronic form of banking conducted through mobile devices, computers, or other
digital channels. According to the Bank for International Settlements (BIS) in their paper "Virtual Banking
and Beyond?" digital banking has revolutionized the financial sector, providing customers with 24/7
accessibility, greater convenience, and lower fees. One of the significant differences between digital
banking and traditional banking is the absence of physical branches, which allows digital banks to offer
more competitive rates and lower costs.

Digital banking relies on data analytics and artificial intelligence to provide personalized services and
improve efficiency. However, as highlighted by the BIS paper, digital banking is not without its challenges
and risks. These include the need for robust cybersecurity measures to protect customer data and
prevent fraud, potential digital exclusion, and the regulatory and policy challenges posed by the rapid
pace of innovation and technological change.

Bank Valuation

Bank valuation is a crucial process that is used by investors, regulators, and bank managers to determine
the fair value of a bank. Deev (2011) highlights the challenges associated with valuing banks due to their
complex nature and varying degrees of risk.

The article provides a comprehensive analysis of various methods used for bank valuation, including the
discounted cash flow (DCF) method, price-to-earnings (P/E) ratio, price-to-book (P/B) ratio, dividend
discount model (DDM), and economic value added (EVA).
The DCF method is a widely used valuation technique that involves forecasting future cash flows and
discounting them to present value using a discount rate. The P/E ratio and P/B ratio are market-based
valuation methods that compare a bank's stock price to its earnings or book value per share,
respectively. The DDM is a dividend-based model that values a bank based on its expected future
dividend payments. The EVA approach measures a bank's economic profit relative to its cost of capital.

Aggelopoulos, E. (2017) provides an overview of the two most widely used approaches for bank
valuation: the equity cash flow (ECF) approach and the residual income (RI) approach. The authors
provide a step-by-step guide on how to use these approaches in practice and highlight their advantages
and limitations.

In general, the ECF approach is used to value a bank based on its future cash flow potential, while the RI
approach is used to value a bank based on the residual income generated from its assets after
accounting for the cost of equity. These two approaches provide a comprehensive view of a bank's
performance and are commonly used by financial analysts and investors to assess the bank's value.

The authors also discuss the importance of choosing the appropriate discount rate, terminal value, and
expected growth rate when using these approaches for bank valuation. They emphasize the need to
consider the unique characteristics of the banking industry, such as the regulatory environment, market
competition, and the impact of macroeconomic factors on a bank's performance.

Performance Factor in Banking

The financial performance of a bank is usually measured by various performance parameters such as
return on assets (ROA), return on equity (ROE), net interest margin (NIM), and non-performing loan
(NPL) ratio. These parameters are used to evaluate the bank's profitability, liquidity, and credit quality.
(Anggono, 2017).

The article discusses the significance of ALM in managing liquidity, profitability, and risk, which are
critical factors affecting the financial performance of banks. The liquidity management component of
ALM plays a vital role in maintaining the liquidity of banks and ensuring their financial stability. On the
other hand, profitability management focuses on maximizing the profit of banks through effective
management of interest rate risk and credit risk.

Moreover, the article highlights the importance of the NPL ratio as a critical parameter for evaluating the
credit quality of banks. The NPL ratio represents the proportion of non-performing loans to total loans
and is an indicator of the credit risk faced by the bank. The study found that effective management of
liquidity and interest rate risk through ALM has a significant positive impact on the NPL ratio, which, in
turn, affects the financial performance of banks.

(Malik, et. all, 2020) uses several variables for analyzing banking financial performance, namely the
capital adequacy ratio (CAR), liquidity ratio uses loan to deposit ratio (LDR), and for profitability ratio
uses return on assests (ROA). This study explores the financial performance of banking industries in the
ASEAN-5 countries, namely Indonesia, Malaysia, the Philippines, Singapore, and Thailand, in the digital
era. The article investigates the effects of digitalization on the financial performance of banks in the
region and compares their performance using various financial indicators.

According to the study's findings, the financial performance of ASEAN-5 banks differs significantly from
that of banks in other ASEAN countries, and the average value of Indonesian banking financial
performance is superior to that of the other four ASEAN countries based on CAR, ROA, and NIM ratios.
However, the LDR ratio indicates that Singapore, Malaysia, and Thailand are superior to Indonesia on
average. Two of the five variables have a considerable impact on the profitability of banks, particularly
the introduction of digital banking and funding variables from third parties.

DATA & RESEARCH METHOD

Data

This study use financial statement datasets as secondary data taken from yahoo finance and investing.
This financial statement datasets contain several digital banks income statement, balance sheet, and
cashflow. These datasets are then used for calculate valuation of digital bank. The sample digital bank
that been analyze in this study is PT Bank Jago Tbk, PT Allo Bank Tbk, and PT Bank Raya Indonesia Tbk.
These sample has been selected because they are the biggest digital bank in Indonesia based on market
capitalization. These financial statement datasets then construct to get each of digital bank valuation
using equity cash flow model. As per Aggelopoulos, E. (2017) study, equity cash flow (ECF) method
should be used for valuing bank because the operating and financing decisions cannot be separated
since interest income and expense (components of financing decisions) are important elements of the
bank’s operating income.

Research Method

explain the proposed research models to answer the research questions or to test the hypotheses,
developed from past literature; lists and explains the dependent and independent variables, the
additional tests that are going to be used in this research

This study use porter’s five forces analysis and SWOT analysis to answer first research questions, RQ1,
which is to elaborate digital bank business trend in Indonesia. Porter’s five forces theory helps to identify
the competitiveness of the digital banking industry in Indonesia. The five forces that are analyzed are the
threat of new entrants, the bargaining power of buyers and suppliers, the threat of substitute products or
services, and the intensity of competitive rivalry. SWOT analysis are also selected because this method
helps to identify the strengths, weaknesses, opportunities, and threats of the digital banking industry in
Indonesia. It provides an overview of the internal and external factors that affect the business and helps
in developing effective strategies.

To answer RQ2 which is calculate digital banking valuation, discounted ECF (Equity Cash Flow) model is
used in this study for company valuation that similar with Aggelopoulos, E. (2017) research. Discounted
ECF is the most appropriate model for valuing financial institutions. The bank’s equity cash flows can be
calculated either directly (direct approach) or indirectly (indirect approach), where both approaches lead
to the same result.

In the research model, the first is to calculate future free cash flow to equity with this equation Koller,
Goedhart and Wessels, (2005)::

CFEt = future cash flow to equity

NIt = net income
ΔEt = increase in the book value of equity
OCIt = other comprehensive income

After deducting all expenses, including payments to depositors and debt holders, net income indicates
the theoretical earnings available to stockholders. However, net income is not cash flow in isolation. As a
bank grows, it will need to increase its equity; otherwise, its ratio of debt plus deposits to equity would
increase, causing regulators and customers to worry about the bank's stability. Increases in equity lower
equity cash flow because they indicate that the bank is issuing more shares or allocating earnings that
may be distributed to shareholders. The final stage in computing equity cash flow is to include additional
comprehensive income, such as net unrealized gains and losses on certain equity and debt assets,
hedging operations, adjustments to the minimum capital requirement, and hedging activities.

The methodology for this study is divided into two stage. The first stage is to determine terminal value
(TV) which represents anticipated value of an asset on a certain date in the future. The terminal value are
obtained after we calculate future cash flow as it mention before. The determined terminal value then is
presented value so we get PV of TV which will be used in the next stage. The other variable that be
presented value is free cash flow (FCF) which has been determined before.

The second stage in this study is determined equity value and enterprise value which represents total
value of entire business (excluding cash). Those values are determined by PV of TV and PV of FCF. So the
present value of terminal value and present value of free cash flow become the independent variable in
the second stage. The research model are presented in figure 2.

The CFE we obtained before is used for calculation the equity value of a company which is equals to the
present value of its future cash flow to equity (CFE),

Ve = equity value of the company

CFEt = future cash flow to equity
ke = discount at the cost of equity
 Figures. 2 Relationship between variable in discounted ECF (Equity Cash Flow) Model

There are several variables that affect other variables, there are variables that stand alone/ doesn’t has
effect from other variable. The detail explanation of each variable are presented in table below. Table.1
illustrate variable that construct terminal value which is important in DCF model. Table. 2 illustrate
Enterprise value and equity value which is the result or dependent variable from DFC model.

Table 1. Terminal Value Model

Terminal Value Model

Variables Measurement Notation
Dependent Terminal Value Value of business on a certain date in the TVAL
Variables future
Present Value of Value of business now based on terminal value PVTVAL
Terminal Value
Present Value of Free Value of cashflow now based on future PVFCF
Cash Flow cashflow
Independent Depreciation the systematic allocation of the cost of a DEPR
Variables tangible asset over its useful life
Amortization the process of allocating the cost of an AMOR
intangible asset over a specific period of time
Changes in Working the difference between a company's current DWORK
Capital assets and its current liabilities.
Net Capital the amount of money a company spends on NCAPX
Expenditure long-term assets
Net Borrowing the difference between the amount of money NBOR
a company borrows and the amount it repays
 Free Cash Flow the amount of cash a company generates from FCF
its operations after subtracting capital
expenditures.
Discount Rate the rate of return used to discount future cash DRATE
flows to their present value
Growth Rate the expected rate at which a company's GRATE
earnings or cash flows will grow in the future

Table 2. Enterprise Value Model

Enterprise Value Model

Variables Measurement Notation
Dependent Equity Value Value of the company's shares and loans that EQV
Variables the shareholders have made available to the
business
Enterprise Value Total Value of Entire Business (Excluding Cash) ETV
Independent Terminal Value Value of business on a certain date in the future TVAL
Variables Present Value of Value of business now based on terminal value PVTVAL
Terminal Value
Present Value of Free Value of cashflow now based on future PVFCF
Cash Flow cashflow

TIMELINE

CONCLUSION