Singapore Banks - Maybank Kim Eng 2019-07-10: Not So Digiciting

Singapore Banks - Maybank Kim Eng Research | SGinvestors.io DBS GROUP HOLDINGS LTD (SGX:D05) OVERSEA-CHINESE BANKING CORP (SGX:O39) UNITED OVERSEAS BANK LTD (SGX:U11)

Singapore Banks - Not So Digiciting


Digital banks will find it hard to upend status quo

  • Even with ultra-aggressive growth the 5 new challenger digital banks are unlikely to gain meaningful market share, our analysis suggests. Singapore incumbents are already deploying sophisticated solutions similar to what digital banks in other markets offer.
  • That said, innovations by these new players can potentially broaden the market, especially for under-served segments. We believe the ultimate prize will be the underbanked in ASEAN, where Singapore’s regulatory, capital and technology ecosystem could be a competitive advantage.
  • Consortiums with access to customer behavioural data, AI analytics and solid regional footprints will likely be the recipients of these new licences, in our view.
  • For immediate regional digital banking exposure, we prefer UOB (SGX:U11) & DBS (SGX:D05).



Non-disruptive disruption

  • There is significant excitement on the disruptive potential of digital banks after the MAS’ announcement on 28 Jun 2019. Expectations have been built that the contenders for the two full digital banking licences and three digital wholesale licences will take on the incumbents and build a sizable user base that will transform the banking landscape in Singapore.
  • Part of the enthusiasm is fuelled by Hong Kong, where the regulator granted eight digital banking licences in May 2019. Rapid user growth in digital banks in the UK, US, Germany, Korea as well as the digital banks deployed by China’s internet giants Alibaba (BABA US) and Tencent (700 HK) has further strengthened interest.
  • In the UK, challenger banks such as Monzo Bank (not listed) has gained over 2 million users in 3-years, while German rival N26 (not listed) has gained 2.3 million users. Since mid-2015, China’s MyBank, which is 30% owned by Ant Financial, part of Alibaba has served 7 million SMEs, according to Reuters. WeBank, the digital bank by Chinese technology company Tencent claims a 0.64% NPL ratio banking first time customers, according to China Banking News (CBN).
  • MAS is set to call for applications by October 2019 and we expect the first official license announcements by year-end. The applicants have to be Singaporean entities, while foreign joint ventures are possible although they will not be allowed to exercise management control.

Gains in Singapore could be smaller

  • Our estimates using synthetic digital banking models suggest that in three years, even with ultra-aggressive growth, the two challenger retail banks will account for just 0.3% of SGD loan market share while the three wholesale challengers will take 0.9% market share (assuming May 2019 system loan balances).
  • Indeed, we estimate that even if these digital banks post ROAs that are double those of the incumbent banks given their expected lower operating costs, the overall virtual banking sector can potentially dilute just 1.3% of 2021E incumbent bank earnings.

Simulating growth in Singapore

  • We attempt to assess the impact of the digital banks on the domestic banking system.
  • The MAS digital banking framework sets out provisions for the following:
    • Two digital full bank licences that can take deposits from the public, while not having any physical branch presence. The initial minimum capital requirement of SGD15m will be raised to SGD1.5bn over time
    • Three digital wholesale bank licences where deposits will be sourced from business banking accounts of SMEs and corporates. Public deposits are allowed only for fixed deposits over SGD250,000. The minimum capital requirement of SGD100m will be raised to SGD1.5bn over time
  • While the starting capital requirements are low (vis-à-vis full bank requirements of a minimum SGD1.5b), the MAS will adopt a sandbox approach with restrictions on the size of deposits (maximum of SGD50m) and product features (plain vanilla lending) in the first 1-2 years. These restrictions will be progressively eased as the banks ramp up.
  • The banks will be subject to the same prudential regulatory oversight as all incumbent players under the framework.

Taking a page from the UK

  • We use the MAS digital banking framework as our starting point and look to the regulator’s current prudential regulations of existing Qualified Full Banks (QFB) for balance sheet risk assumptions.
  • For growth, we look towards the UK digital banking experience. We believe it is more relevant than looking at Chinese examples given dissimilarities in financial inclusion, regulatory restrictions and demographics.
  • The UK has taken several steps to liberalise and encourage digital challengers in the banking industry:
    • In March 2013, the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA) published a review that made it easier, cheaper and more transparent for prospective digital banks to become licensed.
    • In 2014, the Competition and Markets Authority (CMA) introduced the Open Banking Initiative. This together with the implementation of the European Union’s PSD2 initiative will standardise and compel banks to share customer account information and payment services with other market participants.
    • In 2019, capability and innovation grants and incentivised switching schemes will be disbursed to challenger banks.
  • Together with a deep and dynamic FinTech ecosystem, the UK has had a lead in digital banking startups that have scaled.
  • The mandate of the UK regulator seems to be to lead the rapid disruption of the banking landscape. While this is in contrast to the MAS’ approach of cautious, incremental changes, we believe the UK gives us a good view of how greenfield digital banking challengers can pursue ultra-aggressive growth in a market that is well regulated, transparent with similar income demographics to Singapore.
  • For our retail digital bank modelling purposes, we take the examples of Atom Bank (not listed) and Monzo Bank (not listed). Both English banks kicked off in 2015 and have seen rapid growth in their user base to around 2 million each.
  • According to Cruchbase, Monzo has raised around SGD550m of funding from investors including Y Combinator and Stripe. Atom Bank has raised around SGD630m from investors including BBVA.
  • For our wholesale digital bank model, we take OakNorth (not listed) as an example. OakNorth launched in 2015 to serve SME clients using AI driven credit analysis and underwriting. The company has raised around SGD1.3bn from investors including Softbank and Singapore’s GIC and EDBI.

Synthetic virtual bank - Retail

  • Using a starting point of SGD15m of equity and a low asset-to-equity ratio (see by Atom Bank and Monzo when they started), we expect only a small loan-to-deposit ratio of 18%. We expect loan-to-deposit ratios to rise rapidly to levels seen on average by other QFBs in Singapore while we also expect gearing to rise to 15x by Year 3 – this is the upper limit of gearing we have seen in domestic QFBs.
  • We estimate that the overall loan book in Year 3 can increase by 10x y-o-y. For Atom Bank, the loan book increased 12x y-o-y in 2018, while for Monzo this was 7x y-o-y.
  • Assuming both retail bank licensees follow a similar trajectory, by Year 3, they will account for SGD1.9bn of loans - this is 0.3% of Singapore SGD system loan as of end-May 2019.

Synthetic virtual bank - Wholesale

  • With a starting point of SGD100m of capital, we assume lower gearing levels (maximum 6.5x in Year3) relative to the retail operations. Given the focus on wholesale banking, we expect a bigger proportion of funding not to come from deposits, but from the interbank market. When we look at the wholesale banking operations of the domestic banks, we see similar funding structures with a typical loan-to-deposit ratio of 120%.
  • Assuming all 3 wholesale banking licensees expand similarly, by the end of Year 3, these will account for SGD6.2bn of loans. This is equivalent to 0.9% of Singapore SGD system loan as of end-May 2019.

Limited impact in the Medium Term

  • As our analysis shows, even with UK style aggressive growth from inception, the digital challengers will only be able to command around 1.2% market share of system loans.
  • This is on the benign assumption that all incumbents – which includes 33 local, QFB and full bank licensees and 99 wholesale banking licensees - sit still in the face of this competition.


A broader base

  • We believe the best option for digital banks to gain traction in Singapore is to broaden the market rather than compete for market share with incumbents. Unlike some of the other markets where digital banking has seen rapid growth, Singapore does not have any material financial inclusion issues nor access limitation issues for digital banking services.
  • According to the World Bank, in 2017, 98% of those above 15-years have a bank account in Singapore, while 92% of them made or received digital payments over a 12-month period.
  • As a result, the new digital banking challengers will need to offer something differentiated to market segments that are not being served effectively.

A level playing field

  • Ironically, Singapore’s investment in digital infrastructure has created a level playing field for new entrants, while also giving first mover advantages to incumbents.
  • While it is true that Singapore has been late to join the digital banking bandwagon compared to some OECD members, it has been ahead of many markets in terms of digital liberalization. Multiple initiatives have resulted in a forward looking, highly connected digital banking infrastructure, that in some areas are ahead of other developed economies. Some of these initiatives include:
    • MyInfo. Centralised personal data storage backed by the Government. Provides a single, verified authentication framework that enables users to port their data for various services including new bank account opening. This eliminates the need to fill out forms and reduces the need for additional verification documentation when doing online transactions
    • PayNow. Peer-to-peer fund transfer service that allows for instant payments with just the user’s phone, ID card number or corporate ID (for companies). This has reduced the complexity of transactions for users and is bringing more payments online vs. traditional cash settlements.
    • Open banking APIs. In 2016, MAS was the first Asia Pacific regulator to release open banking guidelines and part of that included use cases and design principles for banking sector APIs (which are pipes to a specific entity’s systems or data that allow the creation of applications, even by third-parties). All three local banks are amongst the leaders in Asia for published APIs, which currently range around 150-200 each. These are already being actively used by their customer base including Government Agencies and MNCs.
    • API Exchange. Government led centralised API exchange for convenient and secure data sharing between government agencies with over 100 APIs already in use.
    • SGQR. The world’s first common QR code specification for e-payments with a central infrastructure. This provides a standardized digital payment option that eases usage and processing for customers, banks and merchants.
    • UPOS. Unified point of sale infrastructure that can accept multiple modes of payments from credit cards, QR codes, to Apple Pay and Google Wallet. This reduces complexity and transaction costs for merchants and eases processing for banks and other service providers.
    • Account based ticketing. Integrating micro-payments used for public transport etc. to contactless payment options such as credit cards, Apple Pay etc. rather than carrying an additional stored value card.
  • This infrastructure means that a new entrant can easily plug and play their offering without having to build time consuming and expensive backend logistics. However, it also means that the incumbents have had access to these services first.

In other markets, digital banks offer convenience

  • In markets such as UK, EU and the US, the primary differentiator touted by digital banks is convenience. They offer instant account opening, instant (and free) cash transfers and in App budgeting/money management tools to help better visualise and categorise expenses.
  • In Singapore, the three domestic banks offer accounts that already largely have these features.

Digital banks are unlikely to compete on deposit pricing

  • There is a market expectation that digital banks may offer higher interest rates on deposits, especially as they build their bases. Certainly, in other markets where digital banks compete the banks have offered rates marginally higher than the existing players.
  • That said, the Singapore domestic banks have a long history of effectively defending their deposit market share from other challengers including competition from qualified full banks (QFB) and digital wallets.
  • In the past 4-years, SIBOR has increased 142bps in sympathy with US rate hikes. However, during the same period these banks have managed to increase their market share by 53bps in SGD deposits.
  • Given their sizable market share and sticky platforms that they have built where customer salaries are credited and direct debit payments are transacted, it is hard for a customer to switch for a marginally higher rate. Additionally, these banks tend to hold the primary transaction accounts and cash management accounts for large corporates and MNCs, which are again hard to shift.
  • Given their sizable deposit bases, the 3 domestic banks enjoy deposit funding costs that are 20-82bps below SIBOR as of 1Q19. Given Fig 6 is based on group level costs – which includes higher cost foreign operations – the actual SGD deposit costs should be significantly lower, we estimate. This also means these banks have significant headroom to compete on deposit pricing should the need arise.
  • Any challenger will need to fund themselves off the interbank market (SIBOR) for initial growth. Given this is a significantly higher funding cost base, we believe competing on pricing with the domestic banks will have a material impact on digital bank margins. As such, aggressive price competition is an unlikely path for them to follow, in our view.

Digital Wallets haven’t successfully poached deposits

  • Separately, we note that digital wallet platforms such as EZ-Link, NETS Flashpay, Grab Pay and Fave have existed for quite some time. These platforms, while not paying interest, offers significant lifestyle and other incentives for topping up balances and are branded to appeal to millennials. However, the actual leakage from deposits to these platforms have been minimal since data became available in 2H16.
  • Indeed between 2016 and 2018, the value stored in digital wallets have fallen relative to deposits despite increasing incentives. Instant transfers and QR code driven transaction options offered by the banks themselves, may be a cause for this fall. As a result, we believe digital banks may have to offer even more significant inducements to actually cause any material switch in customer deposits.

Branches still have appeal

  • A primary attraction of digital banking is the ability to access banking on demand without the need to visit physical branches. However, despite already having access to online and mobile based transaction facilities, Singaporeans prefer branch access for higher value, advisory linked transactions such as wealth management and mortgages, according to the Deloitte Banking Attitudes, Behaviours and Preferences survey, May 2018.
  • Additionally, the domestic banks have been investing in improving branch experience through investing in technology and better frontline employee training. UOB, for example, is using AI and Big Data analytics to offer highly customised services when welcoming customers to their flagship Orchard Road branch. Similarly, Maybank Singapore’s (MAY MK) MSpace Branch concept incorporates lifestyle features such as cafes and special events to create a differentiated experience, especially for millennial customers.
  • In a survey by Cornerstone Advisors in 2Q19, 49% of US young millennials (aged 21-29 years) and 54% of older millennials (aged 30-38 years) stated that convenient branch locations is a top 3 most important factor in opening their primary bank account – despite branchless digital banking services being available for nearly a decade there.

Branchless: A critical advantage?

  • Digital banks, by being branchless, should have a better returns outlook from lower operating costs. However, for the 3 domestic banks, facilities costs as a proportion of assets is quite small relative to their ROA (7bps on average vs. 103bps ROA). As a result, it is unclear whether branchless costs savings by digital banks will be a sustainable critical advantage over time.
  • On the other hand, these banks have been spending substantially on technology, particularly DBS and UOB. We believe these investments in platforms and integrating their diverse product segments may be a critical advantage. For example, these unified systems enabled UOB to launch their own digital bank “TMRW” in Thailand in February 2019. They managed to launch a fully functioning system with over 500 features and 200 APIs in its first version in just 18-months from conception to market.
  • To us, this provides insight on the strength of the technology platforms of the incumbent banks in Singapore.

Higher risks to banks with smaller branch networks

  • Ironically, QFB’s with smaller branch footprints and weaker digital offerings will be at a higher risk from digital banking competition. As we discuss earlier, customers look for convenient branch access for their primary accounts. A strong digital service offering will complement this by increasing switching costs.
  • Customers of banks where branch access is inadequate and the digital offering is limited may choose to switch over to digital banks for more convenience.

Opportunities with the underbanked

  • We believe the real opportunities for digital banks lie not in competing for market share in the existing market, but through broadening the overall marketplace.
  • We believe the incumbent players are predisposed on serving higher value customer segments through products such as wealth management, premium banking in the retail segment and large corporates and established SMEs in the wholesale segment. In both cases, these involve customers with proven track records and relatively larger disposable incomes.
  • While their products offer entry level solutions for younger, millennial customers who are starting out in life (that have higher interest rates and fee waivers for limited time periods) the level of depth in these products are limited, in our view.
  • We believe this segment is banked more with a view of building a future customer pipeline rather than real engagement for near-term profitability.
  • Despite over 100% wireless and internet connectively, Singapore’s young millennials (15-24 year olds) have noticeably lower engagement in performing online purchases or accessing online banking compared to other developed economies.
  • We believe this is likely driven off the lack of engaging products for this segment making it a critically under-served segment in Singapore. Digital banking models with their lower cost bases and automated processing will likely see better profitability here compared to the incumbents.
  • By offering lower cost banking services and more lifestyle linked products, digital banks may be able to improve returns from this segment. Even in other markets, digital banks are focusing on this segment. Looking at the average deposit size per account for some of Europe’s and Korea’s leading digital banks, we see from their small size that it is mostly younger, early income customers who bank with them.
  • We believe in Singapore, too, the early income, millennial segment will be a key market for the digital bank challengers.

Risk management is key

  • We believe part of the reason incumbent banks have not focused on banking early income millennials or new SMEs and startups is the cost of compliance and risk management.
  • Allocating KYC procedures or risk management resources to a large volume of low yielding accounts is unlikely to be returns positive. Digital banks are uniquely geared towards solving this problem through automating onboarding and KYC procedures while also managing risks through AI analytics and machine learning.
  • China’s internet giants led MyBank and WeBank have shown how processing costs for previously unbanked customers or low yield customers can be lowered. According to Reuters, MyBank’s cost of approving a SME loan is around CNY2 compared to CNY2,000 for a traditional bank. Since launching, MyBank has been able to extend credit to over 7 million customers, using their big data and AI driven algorithms. According to Management, 80% of MyBank’s clients are first time borrowers and 90% of customers are from lower-tier cities in China.
  • WeBank leverages on data generated from their sister company, WeChat, to gain insights on user behaviour and finances. This has enabled the bank to manage their credit risks effectively and deliver a NPL ratio of just 0.64% compared to the national average of 1.89% (according to the PBOC).
  • However, we are cautious given none of these AI and big data algorithms have been tested through a full banking cycle. NPL levels are currently low given the ultra-rapid pace of loan expansion and a generally lower interest rate environment when these banks scaled their businesses.
  • AI algorithms are largely sophisticated statistical models being solved by enormous computing power. The last time the financial industry used sophisticated statistical models to cycle-proof an industry, we had the GFC – which was partly triggered by models mispricing collateralised debt obligation (CDO) risks.
  • Unsecured debt charge-off nearly tripled in the UK during the GFC. It has seen significant volatility through other negative economic events since then as well.
  • Given a primary segment of digital banking customers are lower income and higher risk, with limited access to assets, they may be taking on significantly more risks on their balance sheets than what can be currently measured.
  • As this industry becomes systemically important, regulators will need to conduct additional stress tests not just on the existing balance sheets but also on their underlying risk management and onboarding algorithms, we believe.


Winning ASEAN, not Singapore

  • Tech, Regulation and Capital: A winning combination
  • Singapore’s highly competitive banking sector, equal access to financial technology infrastructure and already sophisticated digital offerings from incumbents means that digital banks are unlikely to make any material changes to the status quo in the medium term. However, Singapore’s startup friendly eco-system with access to capital, talent and a highly reputed and supportive regulator means there are significant growth opportunities outside Singapore – particularly in ASEAN.
  • Singapore’s banking regulator, MAS, is also working with IFC to establish the ASEAN Financial Innovations Network (AFIN) with an aim to facilitate the adoption of fintech across the region. This will further support digital banking expansion out of Singapore, in our view.
  • We believe digital banking offerings developed and tested in Singapore will have a competitive advantage in these economies.
  • Banking penetration in ASEAN remains low while incomes have been growing rapidly. The domestic banking systems are still catching up in terms of regulatory best practices (Singapore and Malaysia are the only country in ASEAN under the latest BASEL III banking regulatory framework) and technology systems are generally still being upgraded.
  • increasingly using these services. For example, in Indonesia, 12% younger millennials are using digital platforms to access their bank accounts vs. just 6% for older millennials. Increasingly, younger demographics are using digital payments for transactions.
  • These provide a strong opportunity for disruption from challenger digital banks in these markets, in our view.

All for one strategy for digital banking licences

  • MAS will begin accepting licensing applications in October 2019. Under their digital banking framework, the regulator will look at 3 specific criteria:
    • Players with track records in operating in technology or e-commerce,
    • A value proposition to serve existing unmet or underserved customer segments,
    • A sustainable and scalable digital banking business model.
  • We believe the players who bid as consortiums combining their individual areas of expertise will have the highest chance of meeting these criteria and successfully obtaining a license.
  • In the recently concluded Hong Kong digital banking licensing round, most of the successful applicants were consortiums with complimentary skills.
  • Similarly, we believe applicants with complementary skills in 3 critical areas will have a higher chance of obtaining a license in Singapore.
    • Access to customer behavioural data. Platforms in e-commerce, sharing economy companies and telcos that have access to and can leverage deep customer behavioural data. They have the ability to mine insights to deliver specific products, forecast user behaviour and provide risk management inputs
    • Access to AI credit analytics. Big data and Artificial Intelligence companies that have developed credit scoring and insight engines for non-traditional clients. These can provide support in client onboarding and asset quality management
    • Strong regional footprint. Banks that have access to regional markets and potentially customer financial behaviour data in these markets. These players can provide valuable intelligence through multiple banking cycles that can provide insights and training for AI systems to be deployed

UOB and DBS for immediate regional exposure

  • While digital banking will take time to get off the ground, we believe both UOB and DBS offers immediate exposure to the ASEAN digital banking theme.
  • Both offer quite a large selection of services US and European challenger banks provide, while in some areas particularly in SMEs, they are ahead, in our view.
  • In terms of the solutions these banks offer, for DBS they include:
    • A fully branchless, digital bank in India with 2.4m users
    • A fully, branchless, digital bank in Indonesia with 400,000 users
    • DBS Max: A mobile QR code based cash collection solution for SMEs
    • A partnership with GoJek – one of SE Asia’s largest sharing economy platforms
    • HeveaConnect – an end-to-end trading solution for the rubber industry
    • Agrocorp – A cross-border blockchain trade platform for the agriculture value chain
    • An automotive blockchain platform for the Chinese automotive sector
    • Home Credit Indonesia – automated approvals for mortgages in minutes
    • Automatic toll top ups through the digibanking App in Indonesia
    • Foodster – a retail chatbot for food ordering
    • Euromoney named DBS the ‘World’s Best Digital Bank’ in 2018
  • For UOB they include:
    • A fully branchless, digital bank in Thailand with 290,000 App downloads in the first 2-months of operations
    • UOB Mighty – an integrated digital App that provides FX for travel, e-commerce and trading as well as offering lifestyle products
    • Contactless ATM – ATM withdrawals by tapping customer phones
    • Personetics – Multi-lingual chatbot service
    • Meniga – AI insight engine and advanced transaction categorisation
    • Avatec.AI – alternative credit scoring systems
    • Prive – AI driven portfolio wealth advisory
    • Tookitaki – AI driven anti-money laundering process
    • The Asset award UOB the ‘Most Innovative Mobile Banking Application’ in 2019
  • Both banks have been ramping IT expenditure to develop fully integrated systems that are capable of straight through processing. Also their systems are designed to maximise customer and stakeholder insight through Big Data and AI.
  • UOB’s IT expenditure has increased at 21%CAGR in the past 5-years and we expect it to double from current levels (16% of total opex) by 2021E. DBS’s IT expenditure has increased from 15% of total opex prior to GFC to an average of around 18% over the past 5-years.
  • As a result, we believe UOB and DBS offer immediate exposure to ASEAN digital banking, while improving balance sheet mix, rising margins and lower credit costs should provide strong dividend visibility over the medium term.
  • Maintain POSITIVE.





Thilan Wickramasinghe Maybank Kim Eng Research | https://www.maybank-ke.com.sg/ 2019-07-10
SGX Stock Analyst Report BUY MAINTAIN BUY 29.460 SAME 29.460
HOLD MAINTAIN HOLD 11.070 SAME 11.070
BUY MAINTAIN BUY 28.970 SAME 28.970



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