Retail banking is bruising for a battle

Retail banking is bruising for a battle

The African continent is one of the fastest growing and most profitable banking markets of any global region. Dynamic innovation, particularly within retail banking, is delivering solutions to remedy low levels of penetration and a historic reliance on cash. Advances in technology are helping to address sparse credit bureau coverage and limited branch and ATM networks, while significantly reducing the cost to serve customers

By examining the rising disruptors in retail banking, it is evident that now is a great time to be a customer. However, should large bank management teams fail to adapt to evolving technological innovations and customer preferences, they will be increasingly penalised.

The disruptors’ target
South African banks stand out relative to global competitors for a high reliance on retail transactional account fees, as is evident in the right chart below. Their profit contribution from retail transactional activity is approximately three times that of global banks1– the change in the composition of this R42 billion revenue pool over the past three years is shown below left.

New entrants targeting this revenue pool have emerged on several fronts. These include insurers muscling into banking (Discovery and Old Mutual), unsecured lenders offering transactional accounts (African Bank), and the launch of completely new brands (TymeBank) – with Postbank and Bank Zero still to come.

Not all disruptors have acquired their own banking licences, as is the case with Old Mutual, who uses Bidvest Bank’s licence. There are also subtle differences in product offerings, target markets, and pricing and distribution strategies. Although all new entrants have ambitions to extend credit, TymeBank currently offers no lending products, while the remaining players only offer unsecured loans. Discovery, targeting a higher income customer, offers a reward-rich, higher-priced transactional account incentivising customers to buy multiple financial products across the group. On the other hand, TymeBank and African Bank provide simple, but compelling low-cost propositions.

African banks have the second highest cost-to-asset ratio of any region in the world, at 3.6%2. South African banks (other than Nedbank) fare no better and, to date, high margins have tended to protect African banks’ bottom lines. In the face of this inefficiency, South African banks have increased banking fees by 1% in excess of CPI3, since 2008.

Limited mobile money use
These high margins have also caught the attention of several non-bank competitors. Retailers (eg PEP Money/Shoprite Money) and telecommunication companies (eg MTN Mobile Money) have, to varying degrees of success, launched mobile money solutions to disrupt the transactional revenue pool.

Despite high mobile phone penetration, these accounts have achieved limited success in South Africa as regulatory limitations force these solutions to be offered in partnership with a bank, reducing both profitability and flexibility. Also, mobile money solutions don’t operate across providers, therefore limiting “network” size. Furthermore, financial inclusion – measured by the share of the population that has a bank account – is fairly high, reducing the need for mobile money accounts, relative to countries like Kenya, which have low formal banking penetration.

Digital innovations change the game
Other than Capitec, South Africa has seen no banks of scale enter the market since the consolidation of the industry in the early 2000s. That is not to say some haven’t tried. “Operating without the costs of branch infrastructure or high staff numbers, we can offer exceptional interest rates and low fees” sounds like the rallying cry of a new 2019 banking entrant, but in fact was the pitch of 20Twenty upon launch in 2001. Despite offering fanatical customer service and value for money, its ill-fated ownership by Saambou, limited client acceptance of digital channels at the time, combined with dated Microsoft-based IT (information technology) systems, contributed to its ultimate demise.

Digital technologies are now fundamentally changing the way the customer is served and reached. The ability to process large amounts of data at low cost together with the advancements in machine learning and artificial intelligence, and affordable means to automate processes through robotics, is enabling the creation of new competitors. Consequently, they offer compelling customer propositions at a fraction of the cost of the established banks. Quicker product innovation is also easier to deliver.

Affordable distribution at scale is no longer the stumbling block it once was. New entrants can grow their customer base and interact directly without the need to develop costly branch networks and hire significant numbers of staff. TymeBank, for example, has deployed easy-to-use kiosks across the Pick n Pay store footprint, using fingerprint biometrics to open an account and receive a debit card within minutes. It has grown to 1 000 000 customers within nine months of launching, while employing less than 170 full time staff – one of the fastest known global rates of banking customer acquisition. In comparison, Capitec took nearly six years and employed over 2 100 employees before achieving similar numbers.

The significant changes in bank business models enabled by new technology means that even Capitec (a recent disruptor itself) is at risk of disruption. New challengers have undercut transactional fees, offer higher interest rates on savings and, while still unproven, communicate an ability to price loans more keenly. The chart below reflects retail transactional revenue contribution to group revenues.

Incumbents are not lying down
In response to these threats, bank incumbents are devoting significant resources to develop alternative revenue streams, reduce manual processes, improve digital solutions and cut costs. Despite successfully migrating millions of customers to lower cost digital solutions and an increasing ability to reduce headcount, the reality is that it remains quicker and simpler to start a bank with off-the-shelf software solutions rather than simplifying existing large incumbent bank IT infrastructure and branch networks.

IT is one of the biggest areas of cost for large incumbent banks. Over the last five years ABSA, FirstRand, Nedbank and Standard Bank have spent in excess of R185 billion on IT. While the product set is not comparable, the newly revitalised African Bank restricted their IT spend to below R500 million for their recently launched transactional account offering.

Bank customer switching rates in South Africa are low and, while such inertia means that change is gradual, it permits the big banks time to copy ideas. A lack of trust of financial start-ups often limits customer switching – TymeBank’s decision to partner with Pick n Pay helped mitigate this impediment.

From a client offering perspective, incumbent banks have launched lower cost transactional account offerings, but large existing profit pools make them reticent towards aggressively promoting these products. Incumbent banks are increasingly partnering with new “fintech” companies to reshape their cost bases and better serve customers (eg Standard Bank’s investment in Merchant Capital). Although costly to maintain, established branch footprints do retain value, even in a digitized world, serving as an important sales channel.

You expect us to pay for deposits?
New entrants also pose a threat to incumbent bank funding costs, ie the low deposit rates banks offer clients. African Bank, TymeBank and Discovery Bank have all followed in Capitec’s footsteps by offering attractive interest rates on “lazy deposits” (cash kept in ordinary transactional bank accounts) – something incumbents do not do. If the incumbents are forced to match such high “lazy deposit” pricing, up to 10% of their profit base may be eroded.

The customer is king
New banks are increasingly positioning themselves on the side of the customer. Banks used to charge customers punitive fees for making “mistakes”. For example, instead of alerting customers to a potential cash shortfall on their account, they would allow a scheduled payment to put the client into overdraft and then charge a significant fee. New disruptor banks are abolishing these practices.

Discovery Bank actively markets itself as a “behavioural bank”, with the intent to encourage “good” behaviour, such as increased savings, to improve the financial health of the customer. The bank, in turn, benefits through reduced credit losses. TymeBank’s TymeCoach initiative, still in development, also signals its ambition to manage more of its customers’ financial lives.

Platform plays – the new norm
While challengers have launched with a limited product set, the ultimate goal is to use insights garnered by processing customers’ banking transactions to develop a broader set of products and services. What sets TymeBank apart is its willingness to sell third-party products. This is similar to the likes of Starling, a UK challenger bank that links customers to partner products ranging from accounting solutions, to investments, to mortgage broking. Conceptually, this could extend to a credit card offering being funded by a third party, meaning loan growth need not be constrained by deposit growth. The platform creates value by efficiently connecting producers of financial products with consumers, enabled by top-notch data analysis. Locally, FirstRand and Discovery are most progressed in adopting an ecosystem mindset.

More than just retail banking at stake
Aside from developments in retail banking, other profit pools are also at risk. We expect a number of innovative SME business banking solutions to be launched in coming years that will threaten what has to date been a profitable, but sometimes poorly served market.

While the ultimate success of challenger banks and their disruptive impact on the SA financial services sector will not be known for some time, it is apparent that new banking models will increase competitive pressures in the market. Certain banks, such as FirstRand and Capitec, appear better placed to fend off these risks. Regardless, industry returns on capital for incumbent banks should compress over time.

1.Citigroup Global Markets Inc. 2.McKinsey & Company 3.Statistics South Africa

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