Banks and the Digitization of Traditional Banks

I. Introduction and Legal Definition

Digital banks, as defined by the Central Bank of Egypt, are “banks that provide banking services through digital channels or platforms using modern technological techniques.”

In practice, they operate without physical branches, offering services entirely through online platforms. The branchless nature is not merely a technological choice but a structural model intended to eliminate the cost and operational burdens associated with traditional banking infrastructure.

A distinction must be drawn between digital banks and similar emerging models. Neobanks operate online without an independent banking license, relying instead on licensed partner banks to deliver core financial services. Their performance is measured largely by the number of onboarded customers. Challenger banks, on the other hand, hold a full banking license, assume regulatory responsibility, and compete directly with traditional banks. Their performance is measured by profit generation through disciplined risk management. This distinction is fundamental: a neobank is a technological interface, while a challenger bank is a complete banking institution under full regulatory scrutiny.

II. Digital Banks vs. Digital Transformation of Traditional Banks

Digital banking should not be confused with the digitization of traditional banks. A native digital bank is built from inception on a modern, cloud-based core infrastructure, integrated end-to-end for real-time operation. Traditional banks typically upgrade their customer interface while retaining legacy backend systems that were not originally designed for digital delivery.

This infrastructural divergence generates measurable cost differences. Pure digital banks operate with significantly lower fixed costs — in many markets, 60–70% lower — due to the absence of physical branches and reduced staffing requirements. Customer journeys reflect this efficiency: opening an account may require 36 interaction steps with a digital bank, compared to 85 steps with some traditional banks. The latter figure illustrates not merely a user experience shortcoming, but a technological limitation embedded within legacy architecture.

III. Licensing Frameworks and Legal Basis

Licensing is the legal foundation that determines the operational capacity and regulatory status of a digital bank. Two prevailing models exist internationally and in the region.

1. Electronic Money License

This license allows the provision of digital payment and wallet services with lower capital requirements. However, it prohibits the use of client funds for lending or investment purposes, and in most jurisdictions, client balances do not fall under conventional deposit protection schemes. Entities under this license may also be restricted from using the term bankcommercially.

2. Full Banking License

A full banking license grants authority to offer the complete spectrum of banking services, including deposit-taking, lending, credit products, and use of client funds for financing. This privilege comes with heightened regulatory obligations, continuous oversight by the Central Bank, and mandatory participation in deposit protection frameworks.

Across the region, Central Banks have developed regulatory structures reflective of their economic priorities. In Saudi Arabia, a digital bank must be incorporated as a local joint-stock company, with founders demonstrating both financial and technological expertise, supported by an exit plan. In Egypt, a minimum paid-up capital of two billion Egyptian pounds is required, along with restrictions on branch establishment and an initial limitation on extending credit to large commercial borrowers. In Kuwait, licensing is structured through four regulated stages with emphasis on environmental and financial sustainability, requiring applicants to present a five-year business plan accompanied by an exit strategy.

IV. Risk Landscape and Supervisory Response

Digital banks must navigate a risk environment distinct from that of traditional institutions. For customers, two concerns dominate public perception. The first is cybersecurity, where the absence of physical channels concentrates systemic risk into a single digital environment. Despite advances in encryption and cloud protection, a significant breach could incapacitate the entire service framework. The second concern is the reduced human element. While automation reduces cost and increases speed, customer trust historically depends on interpersonal engagement — a paradox that digital banks must resolve.

From an institutional perspective, competition presents another challenge. As traditional banks accelerate digital transformation, the competitive advantage of newly-licensed digital banks narrows. Profitability compounds the difficulty: established banks rely on low-cost deposits, while digital banks frequently attract liquidity by offering higher interest rates, increasing their cost of funds and reducing lending margins. Furthermore, the cost of legal compliance — particularly in anti-money laundering (AML) and cybersecurity — absorbs much of the operational savings gained by branch-less models.

Supervisory authorities have therefore shifted attention toward technology-centric oversight. AML compliance under digital onboarding environments requires robust electronic know-your-customer (e-KYC) controls to prevent identity fraud. Cybersecurity frameworks now emphasise resilience, continuity and real-time monitoring, while outsourcing regulation has grown in significance as cloud-native institutions depend heavily on third-party infrastructure.

V. Conclusion

A digital bank is not merely a traditional bank with a mobile application. It is a legally distinct model, defined by its licensing category, technological foundation, and risk profile. The structural advantage of digital banks lies in cost efficiency, systemic integration and speed of execution, yet these benefits are counterbalanced by cybersecurity exposure, trust-building challenges, and higher capital costs for liquidity.

Regulators in the region have responded with increasingly mature legal frameworks focused on cyber resilience, e-KYC integrity, outsourcing risk management, and financial stability. As global markets push toward reduced cash dependency and automated fund movement, the need for specialised legislation grows accordingly. A clear regulatory environment enhances market confidence, protects consumers, and ensures that innovation evolves within the boundaries of risk-controlled financial governance.

Digital banking, therefore, represents not merely a technological shift, but a legal and economic restructuring of how financial services are conceived, delivered and supervised.

Dr. Fayez Al-Fadli
Arkan Legal Consultations