Sweden, May. 14 2019 — (Editor's note: This article is part of a series of commentaries on retail banking sectors illustrating how technology disruption forms part of S&P Global Ratings' analysis of banks.)
In a world of faster-moving technology and changing customer preferences, S&P Global Ratings thinks that Swedish banks are well positioned to defend their market position in retail banking against disruption. In our view, collaboration in Sweden among large banks is giving them a leg up over new entrants, and a well-established payment infrastructure intermediated by the banking sector is protecting their business models. But they shouldn't rest on their laurels. Swedish banks need to keep pace with the speed of innovation to retain customers and gain new ones to offer the best platform. The population, attached to technology, is gradually pushing the country toward a cashless society, which leaves an opening for the rising threat of disintermediation from the Big Techs.
Applying our four-factor TRIP (technology, regulation, industry, preferences) analysis, we think Sweden is well advanced in the transformation of banking into a fully digital market. Yet, their strategies differ for customer service channels, depending on the segment (see chart 1).
So what is driving the rapid change and the risk of disruption in Sweden? Customer preference. The country displays one of the highest adoption rates of digital services, and we think its banking sector is responding to that. We observe that mobile banking has already overhauled client interactions and transactions for most large banks. Therefore, we believe these banks, to meet customer demand, need to ensure they are in a position to offer tailored banking services through a multichannel approach. We acknowledge that regulators in Sweden, and in Europe generally, are creating a level playing field in the financial industry, including for fintechs, but the Swedish Financial Supervisory Authority is not actively fostering innovation. As such, we see regulation as a neutral factor to the digital agenda of retail banks.
Industry: Disruption Risk | Low
Cooperation among banks is shutting out disruptors--for now
The Swedish banking market remains highly concentrated and dominated by four main players--Swedbank, Svenska Handelsbanken, SEB, and Nordea Bank--which together have more than 70% of the market in customer loans and deposits.
The banking sector started the transformation process a decade ago, moving rapidly from physical meetings to online and digital interactions, for instance, in response to changing customer preferences. The reduction in the branch network over the last two decades has amounted to substantial savings in costs. Thanks to high cost efficiency, demonstrated by an average cost-to-income ratio of about 53% according to ECB data, combined with sound interest margins, Swedish banks are outperforming their European peers in terms of profitability and cost efficiency. We note that the return on equity of Swedish banks exceeds that on other Western European markets despite their strong capitalization.
Early adoption of online customer interactions has meant that Swedish banks have dedicated significant budgets for automation and customer-focused digitalization activities. As such, well ahead of other European markets, internet and mobile banking became the new normal early on. Swedish banks are accompanying the move to mobile with the transformation of remaining branches into advisory centers.
Digital partnerships among large banks and the sharing of infrastructure are much more pronounced in payment services than in other markets, which we believe create major barriers to entry for potential disruptors. Examples of such cooperation include the mobile payment system "Swish," launched by six Swedish banks in cooperation with Bankgirot and the Swedish Central Bank, and the creation of an electronic identification solution called "BankID," which the majority of the population use (77% of people older than 14 in 2018). Importantly, BankID is also used outside of banking, for example, in the delivery of public services. The existence of joint, convenient payment infrastructure appears to be a showstopper for new players, at least for now.
Some new players have managed to infiltrate the Swedish markets, posing a challenge to the incumbent universal banks. Digital disruptors have conquered niches, such as payment services and consumer finance, where they have taken significant market shares. This has been facilitated by low switching costs and user-friendly and convenient applications. Prime examples are iZettle and Klarna. The former has positioned itself as a provider of payment services to small businesses and the latter is dominating Swedish e-commerce and increasingly pushing into point of sale. We observe that the consumer finance sector, now dominated by new players--both banks and nonbanks--are taking advantage of the latest technology platforms, and are able to adapt to customer demand, for example, by offering loan decisions and cashouts in a few quick steps.
Big Techs are active in Sweden in payment solutions, but so far mainly in cooperation with local incumbents. The full impact on the market is not yet clear, given that they were launched in the past two years. However, we believe that the presence of dominant, well-established domestic solutions with strong market penetration could hinder the Big Techs from gaining traction.
Overall, we believe that the Big Techs don't want to become full-fledged banks, but rather focus on offering financial services in several areas close to their supply chains (perhaps via white-label solutions from existing banks). Potential areas could include consumer lending, working capital financing, or traditional debit and credit cards (see "The Future of Banking: How Much Of A Threat Are Tech Titans To Global Banks?" published Jan. 15, 2018, on RatingsDirect).
Technology: Disruption Risk | High
20 years to internet banking, 20 months to mobile banking, and 2 minutes to cash out a loan
Sweden is among the world's leading countries in the diffusion and use of digital technology across industries. The country, followed by other Nordic countries, topped the UN's global Digital Access Index, which measures the overall ability of individuals in a country to access and use new information and communications technology. The UN indicates that the use of digital technologies by both individuals and corporations is widespread in the country and high--regardless of age, education, income group, or size of the firm--in an international comparison.
Technological development in the country has been fostered by Sweden's ambitious policy objectives, set out in its national digital agenda, and reinforced by society. The government's digital strategy, which was updated in 2017, includes a broadband strategy that targets 1 gigabit of fixed-line coverage for 98% of the population by 2025.
Additionally, the country is progressing gradually toward rolling out 5G wireless, thanks to supportive policies. We acknowledge that the current network infrastructure is more than sufficient for plain-vanilla retail banking. Nevertheless, thanks to solid connectivity, we believe Swedish banks will be well positioned in the future to deliver services based on innovative technologies that might require higher network capacity and speed.
The technological revolution started in the Swedish banking sector well ahead of the other European countries, with adoption of online banking as early as the late 1990s. The transformation gained speed as banks launched the first mobile banking solutions in the 2000s. This development was largely driven by strong customer preferences for new technologies, high internet penetration, and widespread use of mobile phones and later, smartphones. Swedish banks have responded to that by becoming pioneers in developing mobile banking services. Their tech-savvy customers are highly responsive to most convenient and rapid solutions, meaning that banks need to continue investing in technology to stay relevant.
In our view, Sweden's domestic banks are generally well equipped to cope with the challenges of technological advancements. We understand that the leading banks' core banking systems are up to date and capable of adding new modules, and that their customer-facing online and mobile banking solutions are up to speed. We observe that the mobile channel is gaining popularity, surpassing traditional online transactions and customer log-ins for most of the large banks. The reliability and ease of using mobile banking are, in our view, crucial for the banks to remain relevant for their customers' daily needs.
Most large banks have launched open banking platforms based on application programming interfaces (API), to which they can add third-party solutions. The European Payment Services Directive (PSD2) requires banks to share customer data to third parties by September 2019. While this could be seen as a threat, Swedish banks also see the rules as a major opportunity to offer better financial services to their customers. With that, they aim to become the platform operators of choice and, more importantly, continue to own the customer relationship. Like similar regulation in other EU countries, we believe that PSD2 will result in stiffer banking competition in Sweden. Banks will need to defend their market positions, while rethinking their strategies and product offerings. As of now, there is no clear front-runner among the four largest banks.
We note that Sweden has attracted a large amount of fintech investment over the past five years. According to FinTech Global, more than half of investments in the Nordics ended up in Sweden over that period. We believe that the country's thriving startup ecosystem and sizable digitally savvy consumer base are the main reasons for this. As a result, banks are able to team up with innovative start-ups if they manage to onboard them onto their own platforms; if not, others will do so. Examples of partnerships by the large Swedish banks are in areas like data aggregation, savings, and accounting and cash flow management services to small companies and corporates (Tink with SEB, Nordea and SBAB, Capcito with SEB, and Meniga and Asteria with Swedbank, to name a few).
We understand that the use of advanced analytics is being tested, but is still at an early stage. In our view, this will provide banks with massive opportunities to leverage the customer data they have accumulated over the years to customize offers and stay relevant.
Swedish banks are also cooperating for the technological development of a broader Nordic platform. Most notable is "Project 27" (P27; serving 27 million customers), which strives to create a harmonized real-time cross-currency payment infrastructure across the four Nordic countries. This would allow customers to use payment solutions interchangeably across countries and currencies. It could be a further step in harmonizing the Nordic payment market beyond banks' payment apps that could protect them from disruption by Big Techs. The P27 group is still consulting with central banks.
With increasing digitalization of the banking business, the industry will need to strengthen its resilience against cyberattacks. Further joint Nordic initiatives also include the Nordic Financial CERT (Computer Emergency Response Team), a cooperative effort in the field of cybersecurity that aims to identify threats, coordinate incident responses, provide incident-handling support, and ensure overall protection from various cybercriminal activities.
Preferences: Disruption Risk | High
Client preferences are pushing banks to digitize
We believe Swedish banks are well equipped to meet current customer demands. However, dropping behind in technological development could have severe consequences, since Swedish customers are highly responsive to new, more convenient solutions as they arise on the market, regardless of the provider. The banks will need to build on the trust they enjoy with their existing customers, which could be a comparative advantage that newcomers won't have.
The Swedish population, supported by advanced education and digital ability, exhibits extremely high preferences for innovative digital solutions. This is underscored by the very high use of internet services compared with other European markets. For instance, Sweden ranked No. 2 in the EU's Digital Economy and Society Index 2018. The use of the internet extends to the population's banking and payment habits, which show a preference for banking via digital channels and a willingness to trial new and convenient digital banking services, in contrast with many other European markets. Because of the change in customer behavior toward digital, Sweden's use of cash is rapidly declining. In fact, cash in circulation in the Swedish economy has halved over the past 10 years to less than SEK60 billion (€5.6 billion), and the country now ranks No. 3 in the number of card transactions per capita in Europe. Mobile banking is becoming the new normal, outpacing internet banking in logins and the number of initiated transactions (see chart 4).
Mobile payments are well advanced. This is mainly because mobile payments have developed into a convenient solution for small-bill transactions, which used to be predominantly covered by cash (see chart 5). A survey by Riksbank shows the payment app Swish was used more often than cash in 2018 (Sveriges Riksbank: Payment Patterns in Sweden 2018, published May 2018).
Regulation: Disruption Risk | Moderate
Banking regulation provides a level-playing field for newcomers without fostering disruption
We currently consider Sweden's regulatory framework to be a neutral factor for promoting innovation or disrupting retail banking. Although the Swedish regulator has established an innovation center as a single point of contact for companies with new business models, we do not believe regulation will foster disruption in Sweden. Indeed, the Swedish regulator has chosen not to follow a sandbox model because it doesn't view promoting financial innovation as part of its mandate.
There are other factors we believe may allow entrants to test new business models in the Swedish banking market, perhaps more easily than in other markets. For example, the availability and transparency of customer credit data at the credit bureau enables newcomers to assess credit risk at an early stage of business without having a customer relationship history. Another enabler, in our view, is the electronic identification and validation tool, BankID. This example of public-private cooperation, a unified identification tool for customers, may help start-ups fulfill regulatory know-your-customer requirements with less effort than in other markets.
Furthermore, the Swedish central bank is examining the introduction of e-Krona, an electronic form of its currency, as the use of cash for payments drops. This would give the general public access to a digital complement of cash, with a state guarantee on the value of the money. We think the impact of electronic currency on the banking sector, especially on funding and liquidity, would depend largely on the specific features of the currency.
Swedish Bank Ratings Stand Tall, And Their Digital Strength Plays A Key Role
Our credit ratings on Swedish banks remain strong in a global comparison, supported by a benign steady economy, stable operating conditions, and the banks' focus on high levels of capital. We do not see any immediate impact from tech disruption on our Swedish bank ratings in the near term. The Swedish banking sector continues to invest in digital transformation and innovation while keeping high cost efficiency and profitability well above those for peer European banks.
We consider that Sweden's large banks have so far managed to adapt to changing customer preferences by moving their services to digital channels. This is backed by broad cooperation among banks, which for now are protected from disintermediation. Therefore, we believe that incumbent banks are able to maintain business stability and defend their market shares in their core retail banking business. Nevertheless, to retain customers and remain relevant for customers' everyday needs, Swedish banks need to keep closely track of clients' preferences, customize their products and services, and truly digitalize their end-to-end processes.