Banks in Asia could face underwhelming returns and lose business to digital-only newcomers in the coming years, unless they step up investments in technology, according to a study by Morgan Stanley and Oliver Wyman.
Falling interest rates are already crimping returns and banks that do not invest adequately in technology or execute their digitalization strategy well could see a gap of between 4% and 5% in their return on equity versus digital leaders by 2025, according to the Oct. 14 report.
Shares of Asian banks have been hit this year amid high provisions to cover for potential bad loans due to the coronavirus pandemic, prompting banks to reduce dividend payments. Net interest margins have shrunk as central banks went on an easing spree to support economies battling to curb the spread of the virus. Some improvement may be in the offing as countries reopen for business, or where the virus may be under better control, as in China.
Still, the pandemic has underscored the importance of banks to go digital as customers, often being unable to step out of their homes, increasingly switched to mobile apps or digital banking to conduct transactions. Most experts believe that the transition may be permanent.
Asia's banks had a strong run with their growth and profitability in the years leading up to 2020. However, "this success may not be a good guide for the future" as the COVID-19 crisis has put the resilience of the banking sector to test, the Morgan Stanley-Oliver Wyman report said. Revenues have missed forecasts, expenses have come under greater scrutiny, cost of credit has gone higher and there is greater strain on bank infrastructure across Asia.
While some of these pressures may ease once the pandemic recedes, low interest rates will continue to pressure banks' returns, it said. Bank ROE in 2025 will likely be lower than it was in 2019 for all Asian geographies, except India, it said, adding that the decline may be particularly pronounced for lenders in South Korea, Singapore, Hong Kong and Thailand.
Accelerating digitization could help boost revenue and squeeze costs, especially in India, Indonesia and China, the report said. Casting a wider net to capture new digitally savvy customer segments, for example, could broaden a bank's client base.
Streamlining processes in banks via technology would yield cost savings, too. Cloud-based technology is easier to scale up and is cheaper than legacy IT infrastructures, the report noted.
"We believe the digital leaders of today have the opportunity to capitalize on the headstart they have in their digitalization journey to maximize efficiency gains and defend against emerging risks," it said.
And banks are taking note. "As recovery strategies crystallize, digitalizing the organisation has emerged as the highest priority of the post-COVID-19 agenda for many Asian banks looking to return to growth," it said.
The pandemic has accelerated digital adoption and changed customer preferences and expectations for banking services. Up to 65% of leading corporate banks in Asia view digital sales and advisory as important customer needs post-pandemic and 71% of corporate clients see a digital offering as an important factor in selecting a new banking partner, it said.