Singapore Banks - DBS Research 2020-09-24: A Whole New Digital World

Singapore Banks - DBS Research | SGinvestors.io

DBS GROUP HOLDINGS LTD (SGX:D05) OVERSEA-CHINESE BANKING CORP (SGX:O39) UNITED OVERSEAS BANK LTD (SGX:U11)

Singapore Banks - A Whole New Digital World

Some digital bank applicants can bring strategic value, leveraging on alternative data in their existing ecosystems to assess and provide credit to underserved segments.
A platform-based business model is likely to be more scalable and profitable.
Implications: Singapore banks to continue improving their value proposition; new digital banks unlikely to cannibalise Singapore banks’ diversified profit streams in near-term.
Open banking developments, facilitated by MAS, may be a bigger disruption force than digital banks’ entry.

Defining a Digital Bank

As “Digital Bank” becomes an increasingly used term, we attempt to break down what encompasses being a Digital Bank in today’s context to different stakeholders.
From a customer’s perspective (both retail and businesses):
- Trustworthiness: As the old saying goes, “banking is an industry of trust”. From a customer’s perspective, a good Digital Bank first and foremost must be trustworthy and that deposits and transactions going through the bank is safe and secure.
- User Experience (UX) and functionality: UX comprises of a user interface with high customer satisfaction, ease and intuitiveness of usage, design and functionality among others. Ultimately, a good digital bank is likely to have strong product offerings and functionality which allow for most, if not all, types of transactions to be done digitally with ease. This includes the choice of digital solutions to various processes.
- Strong customer support and interaction: While a digital banking model utilises online self-service technologies, strong customer support and interaction is likely to be a plus for a good digital bank.
- Unique value proposition: To a customer, a good digital bank is likely to bring on board some unique value proposition that sets it apart from others. This could come in the form of unique and/or increased access to product offerings, lower fees [if the digital bank is able to pass cost savings by adopting a digital model (assuming there are) to end customers, and not simply undercutting competition] among others.
From the bank’s perspective, a leading digital bank should have the following attributes:
- Digital at the core, strong infrastructure. Banks today may face various legacy infrastructure and core banking systems, unlike digital banks, fintechs and startups. Digitising at its core across various internal processes and legacy infrastructures, core banking systems, and having a strong digital infrastructure are characteristics of a good digital bank.
- Providing digital solutions to customers. Digital solutions to replace current manual processes may include the development of various digital banking platforms, partnering ecosystems and the use of banking application programming interfaces (APIs) in offering digital solutions.
- Strong data analytics capability. Strong data analytics can aid internal credit analysis, credit monitoring and underwriting, as well as fraud detection. The bank should also be able to leverage on data analytics to monetise its existing customer and database and generate increased revenues. This may also involve the use of non-traditional data i.e. alternative data for credit monitoring and underwriting processes.
To a certain extent, to shareholders, a digital banking model may translate into lower cost and higher cost efficiency over time, which would be positive to shareholder’s return.

Looking in Singapore’s banking landscape

Singapore’s banking industry continues to liberalise over the years.

Since 2000, MAS has awarded six Qualifying Full Bank (QFB) licences, to HSBC Bank (Singapore) Limited (2002), Maybank Singapore Limited (2002), State Bank of India (2008), ICICI Bank Limited (2010), Industrial and Commercial Bank of China Limited (2012), Bank of China Limited (2012). Today, there are a total of nine QFBs in Singapore, amid > 100 full banks, wholesale banks and merchant banks.
Recently, MAS announced that Standard Chartered would become the first significantly rooted foreign bank (SRFB) in Singapore, thereby allowing Standard Chartered Bank Singapore to double its footprint in Singapore. Under the enhanced SRFB framework, MAS will consider granting an additional full bank licence to an SRFB that substantially exceeds the baseline criteria, which will allow an SRFB to establish subsidiaries, including joint venture partnerships, and to operate new or alternative business models such as a digital-only bank.

Mature banking industry with high banking penetration.

According to the World Bank, 98% and 92% of Singapore’s population (aged 15 and above) has a bank account (or an account at a financial institution or with a mobile money service provider), and debit card as of 2017. In the credit card space, World Bank estimates close to 70% of the working population has at least one credit card and credit card ownership is at 49% of the population while a credit card consumer holds 4-5 credit cards, suggesting a highly competitive market.
Further, Singapore continues to see high digital banking penetration amid high smartphone penetration of 82%1 with more than 90% of the population having made digital payments and are digitally savvy.

Government’s push towards a digital economy.

The government continues to take the lead in driving digital outcomes, for example PayNow, launched in 2017 as a peer-to-peer funds transfer service that allows retail customers of nine participating banks to send and receive money using only their mobile number or Singapore NRIC or FIN. PayNow Corporate was subsequently launched in 2018 to allow businesses to transfer funds using their Unique Entity Number.
In 2018, SGQR, the world’s first unified payment QR code was launched which combines multiple payment QR codes into a single label, supported by a central infrastructure network, co-owned by MAS and Infocomm Media Development Authority (IMDA).

Local banks have sizeable market share and offer diversified services, while actively increasing cost efficiencies.

Apart from a mature banking landscape with high banking penetration, the local banks have sizeable market share across S$ deposits, loans and mortgages. In the past decade, the local banks have also continued to build diversified income streams on top of net interest income, with non-interest income now accounting for a substantial portion of the banks’ total income.
Local banks have continued to increase their services offerings over the years, which are extremely extensive today, covering banking, credit cards, insurance, loans, investments, brokerage, trade financing, transaction banking, treasury services etc.

Singapore banks have had a headstart in both retail and wholesale banking in a relatively well-banked country.

Since starting on their digital transformation journey in 2010, Singapore banks have launched their respective mobile banking apps, fine-tuning and adding more features along the way, alongside other bank app offerings.
On the wholesale banking front, the Singapore banks currently offer various business banking platforms and solutions. Since January 2019, Singapore banks have partnered with Enterprise Singapore (ESG) and Infocomm Media Development Authority’s (IMDA) on the Start Digital initiative to help SMEs digitise their businesses, making use of various applications in accounting, payroll/ human resource management, cyber security, digital marketing and transactions in their daily operations.
The local banks today offer hundreds of informational and transactional APIs for developers to work with, with DBS and OCBC having more than 200 and 400 APIs respectively (according to their websites).

Open banking is another key industry development to watch.

Development of open banking has been largely facilitated by MAS, which has provided guidelines for open banking/ APIs. Today, MAS operates the Financial Industry API Register to make available Open APIs. We continue to keep watch on developments in open banking, where MAS is aiming at facilitating data portability in the interim.
Eventually, open banking may enable consumers to aggregate their banking, insurance and investment information across banks and financial institutions on a single platform, which may allow for easier comparability and higher level of competitiveness in the banking industry.

Value proposition of a digital bank licence for a new entrant

We believe a good starting point is to examine the value proposition of a digital bank licence from a new entrant in Singapore, given that Singapore has a mature banking industry with high banking penetration.

Access to highly regulated industry which has been profitable for incumbents.

While a digital bank licence allows a new entrant to enter a new business which is highly regulated, profitability for incumbents does not necessarily ensure profitability for the new entrants. Some applicants may already have experience of operating profitable digital banks in other countries.

A bigger banking empire.

Some applicants may be also interested in securing digital bank licences outside of Singapore, which may have a lower banking penetration and larger bankable population. Successful applicants would be able to leverage on its experience in Singapore, with a smaller banking population, to set up digital banks in other countries.
Operating as a restricted digital full bank in Singapore has limitations as these should not establish banking operations in more than two overseas markets, according to MAS.

Synergies with existing businesses.

Applicants may obtain synergies of operating a banking business with its existing ecosystems and businesses. Adding a banking dimension may allow them to increase customer stickiness across their existing businesses, driving profitable outcomes within and across the enlarged ecosystem.

Value proposition a new digital bank could bring to local customers and/or Singapore’s banking industry

There are multiple dimensional groups of customers in our discussion: underserved segments and served segments, across retail as well as wholesale banking customers.

Provide access to credit where it is currently difficult to obtain …

First and foremost, a strong value proposition would be that the new digital bank entrants are able to provide access to credit to underserved segments, where credit is currently difficult or not possible to obtain. Potential underserved segments could be SMEs and micro SMEs with no access to credit, m-o-m-and-pop shops, start-ups with little financial track record and/or assets to pledge as collateral, self-employed workers, gig-economy workers, part-time workers among others. Potential new customers would be the younger generation.
According to MTI, as of Aug 2019, SMEs make up 99% of all businesses in Singapore, employing 72% of the workforce and contributing 47% of Singapore’s GDP. However, based on MAS’ SME Financing Survey in 2017, micro and small enterprises, including unclassified SMEs, only correspond to 57% of banks’ outstanding SME loan portfolio, though they account for 91% of unique SME customers that banks lend to as loan limits for medium-sized SMEs tend to be higher. In 2019, according to MAS, c.80% of outstanding SME loans are secured, highlighting some preference for secured credit to mitigate potential loan losses. Today, local finance companies have a bigger share in the micro loans market, implying the continued relevance of finance companies in SME financing. While the proportion may have improved since, the MAS SME Financing Survey may still point towards some unaddressed gaps in SME financing.

… based on superior alternative data analytics.

SMEs and certain segments of workers may not have easy access to credit due to perceived high risks, such as having little financial track record and/or assets to pledge for financing. As a result, loans may be unsecured and involve high credit spreads due to perceived high risks, resulting in SMEs turning away from lofty interest rates or being turned away as incumbents are unwilling to underwrite the perceived high risks.
Digital banks with intelligent, real-time alternative data of retail or wholesale banking customers in their existing ecosystems, may be able to leverage on their superior alternative data analytics to determine credit worthiness and price risk more accurately. They would be able to provide credit not previously provided by traditional banks, on top of credit monitoring efforts. Ant Group has been successful in this front in China, leveraging on its credit scoring systems with voluminous transaction data of consumers and merchants via its Alipay payments infrastructure.

New and/or differentiated products and offerings with fast turnaround time.

Digital banks could introduce new products and offerings with fast turnaround time, on top of the traditional deposits-and-lending banking model, and gain traction among the target group. Digital banks could also potentially offer investment products, and continue to drive digital adoption across SMEs, micro SMEs and m-o-m and pop shops, encouraging cashless adoption.
Today, there are still some segments of merchants still attached to cash transactions, possibly because of low willingness to adopt digital payments and/or infrastructure costs associated.

UX and customer experience.

Lastly, a more intangible value proposition a digital bank could bring to customers would be in terms of UX and customer experience. Looking across to the local telco industry, Circles.Life has managed to attract customers partly due to the ease of sign-ups and usage where customers can modify and add-on to mobile plans’ offerings in real time via its app.

Possible offerings of a digital bank in Singapore in the initial phase

Ongoing brand building.

The new players are likely to spend marketing dollars on brand building and various campaigns to attract customers.

Expect varying promotion tactics and/or unique offerings to acquire retail customers.

The new digital full banks are likely to leverage on their existing customer base as a start to acquire new retail banking customers. Applicants like Grab-Singtel consortium, Sea, Razer Youth Bank consortium all have a substantial existing customer base. Ultimately, the cost of retail customer acquisition is likely to vary across new players due to different starting points. While Mox Bank (Hong Kong) is willing to directly acquire customers for HKD 100, new digital full banks may have different considerations to determine a reasonable cost for acquiring new customers and assessing the lifetime value ascribed to each banking customer.
Other ways of acquiring new customers could be to offer promotional rates for deposits. In the initial years, losses are likely as digital banks continue to spend on customer acquisition. We note that ride hailing players and payment apps such as Dash, Fave, Google Pay have been successful in acquiring customers with S$5-10 free sign-up credits.

Customer stickiness within the ecosystem.

While it may be easy to attract new bank account sign-ups, the uphill task would be to maintain and increase customer stickiness over time. For applicants in an existing ecosystem, it may be easier to promote customer stickiness across the banking and non-banking platforms.

Wholesale banking success depends on degree of penetration.

Wholesale banking success would depend on the digital banks’ ability to onboard customers, price risk appropriately, and generate appropriate returns on lending, and/or offer other relevant solutions for wholesale customers.

Potential business models of digital banks

Potential business models for the new digital banks could be a combination of all three models laid out below:

Basic banking services; other offerings to depend on digital banks’ strategies.

Digital full banks will most likely offer basic banking services such as payments, transactions, loans, cards. Other retail banking offerings could include investments and insurance. For wholesale banking, offering unsecured loans, working capital loans, trade financing, supply chain, inventory financing, among others, would enable them to secure customers.
A balanced business model in the traditional banking space should span across all areas, instead of relying on just one area, such as payments, for revenue. The pandemic has highlighted downside risks of such reliance, for instance, Monzo Bank generates most of its revenue from fees generated on card usage, and subsequently saw revenues dive due to the ongoing pandemic which led to reduced consumer spending.

Platform based model.

An alternative business model could be such that on top of traditional banking offerings, the new digital bank acts as a platform to connect customers to various financial providers, and earns commissions on such transactions. For instance, Ant Group operates Ant Fortune, its wealth management platform where it offers its flagship Yu’e Bao product, on top of products from ~80 Chinese fund institutions. Huabei and Jiebei are Ant Group’s consumer credit platforms, leveraging on Ant’s internal credit model for credit assessment of small unsecured loans. The platform obtains capital from financial institutions and other institutional investors for lending.
Separately, there are now more than 60 insurance companies that sell their policies on Ant’s insurance platform.
Recently, Kakao Bank announced plans to transform to a comprehensive financial services platform. This year, it has launched four credit card programs with various credit card companies where customers apply for the card via Kakao Bank’s platform and credit card companies take care of credit assessment and card issuance, with the cards bearing its mascot.
Kakao Bank has also ushered in > 2 million brokerage account sign-ups through its platform for two domestic stock brokerages.

Digital solutions.

Another plausible business model could take the form of selling digital solutions. For instance, Ping An OneConnect Bank has a separate fintech arm which provides digital solutions for financial institutions.

Limitations a new digital bank entrant might face in Singapore

As discussed in previous sections, we believe that new digital bank entrants are able to leverage on various value propositions to grow organically. At the same time, we list out potential limitations that a new entrant might face in Singapore:

Higher cost of funds.

Today, anecdotally, due to QFBs’ narrower customer base, QFBs may at times have to pay a premium to attract local S$ deposits from existing or new customers to maintain liquidity requirements as well as market presence.
Notably, the premiums of fixed deposits that QFBs and local finance companies (which rely on fixed deposits as primary source of funds) have to pay on top of local banks’ fixed deposit rates might be as high as >1%. Hence, the new digital banks are likely to have higher overall cost of funds compared to the three local banks, or even QFBs. This may affect their ability to price loans affordably.

Existing competition from foreign banks and finance companies.

According to MAS’ observations in the SME Financing Survey in 2017, foreign banks tend to lend more to medium-sized SMEs and offer larger loan amounts than the local banks. Meanwhile, finance companies like Hong Leong Finance, Sing Investments and Finance, and Singapura Finance have vast client relationships in the SME space.
Digital full banks as well as new digital wholesale banks are likely to compete with these existing players, as well as other lending platforms (e.g. P2P) which have made headway into SME financing, to some extent.

Unlikely to see radically low cost to serve.

While the digital banking model has often been touted as one that might generate superior returns due to lower cost-to-serve, we posit that due to inherent limitations of Singapore’s small population, the new digital banks are unlikely to see radically lower cost-to-serve, despite cost savings from absence of physical branches.
Moreover, compliance costs and backhaul infrastructure, in addition to personnel costs, are likely to increase as scale of business grows on top of high initial marketing expenses to acquire customers.

Limitations to setting up.

Digital banks will not be allowed network access to automated teller machines (ATMs) or cash deposit machines (CDMs) though they are able to offer cashback services through electronic funds transfer at point of sale (EFTPOS) terminals at retail merchants which may have a broad network across the island.
According to MAS, the rationale for restricting ATM/CDM access is to encourage digital banks to adopt innovative digital ways of serving customers and supporting the future digital economy. While digital payments are gaining strong traction, ATMs are still a very much a way of life, given there is still attachment to cash transactions as seen in long queues sometimes seen at local banks’ ATMs. However, we do not view this as a big deterrent as retail customers of digital full banks are likely to retain other bank accounts with ATM access.

Credit assessment is still a core function of lending, one that digital banks must get right.

While some digital bank applicants may be able to rely on alternative data and real-time analytics to underwrite credit risk, not all digital banks may have access to such data. Ultimately, digital banks must have a viable credit underwriting process which produces sustainable returns and ensures that non-performing loans ratio across different credit cycles is manageable. The pandemic has highlighted asset quality risks for new digital banks which were not in the spotlight. While it is not difficult to lend out money per se, ensuring collectability is much more difficult. Monzo Bank now expects credit losses to climb to £20m from £4m due to the pandemic, after lending out a substantial £144m in 2019.

Capital requirements.

At a later stage, upon graduation from a restricted digital full bank, the required paid-up capital for digital full banks would be S$1.5bn, a sharp increase from the initial paid-up capital for restricted digital full bank of S$15m. The ability to raise sufficient capital for growth in the future may vary, depending on the shareholder profiles of the successful applicants.

How are incumbents likely to react and a peek into 2025

Singapore digital banks likely to require more effort to acquire and develop meaningful customer stickiness to turn profitable within a small and relatively well-banked population, and well-regulated banking industry in Singapore. Kakao Bank’s success in attracting and monetising its 12 million customer base can be explained by the high proportion of underserved retail customers, amid relative difficulties in obtaining financing from rigid traditional banks which were also late to offer good UX on its banking platforms.
We believe that Singapore digital banks are likely to require more effort to acquire and develop meaningful customer stickiness to turn profitable, given that a large part of the population and businesses in Singapore are relatively well-banked. Further, with only ~3.2 million of the population aged 20 and above, the total addressable retail customer population remains small.
MAS has also most recently in 2019, reduced the limit on unsecured credit facilities to 12x monthly income, to reduce outstanding consumer debt in Singapore.

A platform-based lending model is likely to see higher profitability, though an evolved business model would include aspects of traditional banking features.

We believe that it is possible for digital banks to turn profitable eventually and a platform-based lending model is likely to see higher profitability compared to a traditional lending model. Currently, Ant Group’s take rate on its lending platform is estimated at 2.5%. The funds are from other financial institutions and Ant Group merely serves as a lending platform, which utilises its credit scoring system with its alternative data analytics and internal credit score.
We believe that a platform-based model is likely to deliver higher profitability and is much more scalable, requiring less capital and operational expenses, compared to a traditional deposit-taking and lending banking business model.
However, whether this model can take off also depends on the willingness of other banks and financial institutions to partner the new digital bank to provide capital for its lending business. Incumbents may believe they are better off leveraging on their traditional lending capability and credit cards and unsecured loans business, rather than relying on the new digital bank. Hence, we believe that an evolved business model is likely to see the new digital bank concurrently offering traditional banking services as well.

Singapore banks are likely to continue to deliver value propositions that digital banks can bring to the table.

In the meantime, we believe Singapore banks, having started on their digital journeys for several years now, are likely to continue working on delivering value propositions that digital banks can bring to the table. Compared to banks in other countries, we believe that Singapore banks have garnered relatively good traction in their digital journeys and are well-positioned to enhance their value propositions.
Read the 26-page PDF report attached below for complete analysis on the scene of digital banks and also the summary of Singapore digital bank applicants' profiles.
See also:

Rui Wen LIM DBS Group Research | https://www.dbsvickers.com/ 2020-09-24

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