Singapore Banks - UOB Kay Hian 2021-01-12: The Business Model Of Digital-Only Banks Is Broken?


Singapore Banks - The Business Model Of Digital-Only Banks Is Broken?

  • The odds are against digital-only banks achieving sustainable profitability because customers are demanding and prefer to be served on an omni-channel basis through both online apps and face-to-face interactions at physical branches.
  • Assuming MAS does not interfere with banks’ dividend policies, we expect DBS (SGX:D05) (Target Price: S$31.48) and OCBC (SGX:O39) (Target Price: S$14.62) to provide dividend yields of 4.0% and 4.7% for 2021F and 4.9% and 5.3% for 2022F respectively.
  • Maintain OVERWEIGHT.

Plethora of digital-only challenger banks.

  • Challenger banks provide digital-only and mobile-centric financial services available anytime and anywhere. The number of digital-only challenger banks has increased at a CAGR of 26% since 2010 and expanded by three-fold since 2015. There are 242 digital-only challenger banks around the world as of 2020 (Americas: 45%, Europe, Middle East & Africa: 35% and Asia Pacific: 20%).
  • Growth is encouraged by regulators keen on promoting innovations in the financial services industry. Open banking and electronic-Know Your Client (e-KYC) policies attract and accelerate the entry of new digital-only challenger banks.

Digital-only challenger banks are persistently loss-making.

  • Incumbent brick-and-mortar banks have multiple sources of income compared to digital-only challenger banks that are reliant on transaction fees. Customers at digital-only banks hold 1.5 products compared to five for incumbent banks. Digital-only banks’ weakness centres on the inability to generate revenue: Digital-only banks’ loss per customer has deteriorated from €10-60 pre-COVID-19 to €20-75 post-COVID-19. Incumbent banks’ profit per customer has deteriorated from €150-350 pre-COVID-19 to €50-200 post-COVID-19.

Digital-only banks require continual investor funding.

  • According to McKinsey, “many digital-only banks cannot sustain a cash consumptive business model”. They opined that “The COVID-19 pandemic has shortened the runway for many fintechs, posing an existential threat to the sector”.

Funding has dried up.

  • According to KPMG, total global investment activities in fintech, (encompassing venture capital, private equity and M&A) had dropped by 66% on an annualised basis in 1H20. The party years have ended and investors have started to closely scrutinise the profitability of digital-only banks. Many early-stage fintechs struggled to attract funding. Monzo, a top digital-only bank based in the UK, raised funds at a 40% discount to the previous valuation in Jun 20. In its annual report 2020, Monzo warned that its ability to continue as a going concern is subject to material uncertainties.

Digital-only banks failed to shine during the COVID-19 pandemic.

  • Unlike online shopping, online gaming, video streaming and food delivery, digital-only banks fared poorly during the COVID-19 pandemic. Digital-only challenger banks’ incomes have fallen sharply during the COVID-19 pandemic due to their heavy reliance on transaction fees. The drop in consumer spending and overseas travel has resulted in a steep decline in their main source of revenue – transaction fees.

Customers have lost faith in Monzo and Revolut.

  • Monzo and Revolut received a barrage of complaints from customers shut out of their accounts frozen during the lockdown. Hundreds of customers complained that they could not access their funds as their accounts were frozen without notice. This episode of poor customer service will affect customers’ perception on reliability of digital-only banks.

The barrier to entry is flimsy.

  • Digital-only challenger banks cannot patent the suave user interface on their online app. On the other hand, incumbent brick-and-mortar banks can outspend digital-only challenger banks on technology. They can also copy popular features introduced by digital-only banks.

A change in the narrative.

  • Xinja Bank, a digital-only bank in Australia launched in 2019, has given customers the required seven-day notice to close their savings and transaction accounts. The bank has refunded customer deposits and handed back its banking licence to the Australian Prudential Regulation Authority in Dec 20. Xinja Bank explained that raising capital has become impossible due to the COVID-19 pandemic. It will instead focus on its US share trading platform Dabble.

COVID-19 vaccination is expected to complete by 3Q21.

  • The Ministry of Health has established an expert panel of doctors and scientists to advise on the selection of vaccine candidates and other logistical issues. Singapore received the first shipment of COVID-19 vaccines from Pfizer-BioNTech in Dec 20. Vaccination has commenced with healthcare workers in public and private hospitals in Jan 21, especially those fighting at the frontline. Next, would be the elderly aged 70 and above and those with co-morbidities, followed by those aged 60 to 69. The priority is to protect individuals most vulnerable and more likely to be exposed to COVID-19 infection, while working progressively towards a high level of vaccination in the population.
  • The commencement of vaccination would:
    1. improve business confidence;
    2. ease safe distancing measures; and
    3. reduce stress on the corporate sector, thus moderating NPL formation.
  • Banks, being cyclical stocks, will benefit from an economic recovery as consumer behaviour and domestic consumption normalise when vaccination commences.

Banks to benefit from lower credit costs in 2021.

  • DBS (SGX:D05)’s and OCBC (SGX:O39)’s total provisions for 3Q20 dropped 35% and 53% q-o-q respectively. DBS’s and OCBC’s credit costs for 3Q20 eased to 59bp and 52bp respectively, compared with 104bp and 105bp in 1H20.
  • DBS has maintained guidance for cumulative credit costs in 2020-21 at 80-130p (S$3b- 5b), while that for OCBC is 100-130bp (S$2.5b-3.5b). For DBS, we estimate 2020 provisions at S$2.9b, and to drop to S$1.6b in 2021.
  • OCBC is optimistic that credit costs for 2020-21 could gravitate towards the bottom-end of management’s guidance at 100bp. For OCBC, we estimate provisions at S$2.1b for 2020, and to drop to S$0.9b in 2021.

The regulatory pendulum has swung the other way.

  • Regulators around the globe had restricted banks’ dividend payout in Jun/Jul 20 to ensure they have sufficient capital buffer to absorb loan losses and to support lending to power the economic recovery. Since then, many banks have reported 3Q20 results that were above expectations due to lower provisions for loan losses.
  • Cognisant of the improved outlook for the economy, regulators in the UK, the EU, the US and Australia have eased or removed the caps on dividend payout in 2021.

Gradual normalisation of dividend payout by Singapore banks

  • Singapore banks will resume their roles as yield plays. We envisage a two-step process in normalisation of dividend payout back to their pre-COVID-19 levels.
  • We expect DBS to pay 30 cents per quarter in 2021 and 33 cents per quarter in 2022. Thus, we see dividend yield from DBS improving from 4.0% 2021 to 4.9% in 2022.
  • We expect OCBC to pay 25 cents per half year in 2021 and 28 cents per half year in 2022. Dividend yield from OCBC is expected to improve from 4.7% 2021 to 5.3% in 2022.


  • We are heartened by the COVID-19 vaccination underway. According to Bloomberg, more than 25m doses of COVID-19 vaccines have been administered in 42 countries (China: 9m, US: 8m, UK: 2m, Israel: 1.8m, UAE: 1.1m, Russia: 0.8m and Italy: 0.6m).
  • We have rolled forward our valuations to 2022F. It is more appropriate to value Singapore banks based on 2022F financial performance when credit costs have normalised, which is a better reflection of valuations during an economic up-cycle.
  • BUY DBS (Target Price: S$31.48) and OCBC (Target Price: S$14.62).


  • Assuming MAS does not interfere with banks’ dividend policies, we expect DBS to provide a dividend of S$1.08/share for 2021F and S$1.32/share for 2022F, which represents dividend yields of 4.0% and 4.9% respectively.
  • Our target price of S$31.48 is based on 1.44x 2022F P/B, derived from the Gordon Growth model (ROE: 10.2%, COE: 7.5%, Growth: 1.5%). We have conservatively assumed that the injection of S$463m to support the merger of DBS Bank India and Lakshmi Vilas Bank is fully written-off, which reduces BVPS by S$0.17.
  • See DBS Share Price; DBS Target Price; DBS Analyst Reports; DBS Dividend History; DBS Announcements; DBS Latest News.


Sector Catalysts

  • Gradual recovery in earnings and dividends due to decline in credit costs in 2021F and 2022F.
  • Continued recovery of the Singapore economy accompanied by easing of safe distancing measures.

Assumption Changes

  • We maintain our existing forecasts for earnings and dividends.


  • Escalation of geopolitical tension and trade conflict between the US and China.

Jonathan KOH CFA UOB Kay Hian Research | https://research.uobkayhian.com/ 2021-01-12
SGX Stock Analyst Report BUY MAINTAIN BUY 31.48 UP 26.750
BUY MAINTAIN BUY 14.62 UP 12.850