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Tech Disruption In Retail Banking: Australia's Big Banks Hold Their Ground As Tech Takes Center Stage

(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.)

Australia's major banks are well placed to deal with tech disruptions, backed by their dominant market positions. Nevertheless, the country's banking sector is entering a period of significant change as market participants respond to new technologies and increasing customer demand for tech-driven convenience.

We expect Australian consumers will quickly embrace new financial technologies (fintech) as they become available--in line with their adoption of contactless payments ahead of many other developed countries. We expect younger consumers to lead the charge, as reflected in the current uptake of app-based buy-now pay-later (BNPL) loans, which is skewed toward the young. Although Australia's BNPL market is small, it will likely have an increasing impact on the incumbent credit card market.

In our view, Australia's regulators openly encourage innovation and see technology as a key mechanism to improving customer outcomes. Open banking, for example, will likely be a key driver of Australia's fintech development. We believe open banking will increase competition by giving all accredited parties access to what is currently incumbent banks' proprietary data, accelerating the rollout of technology to consumers by making it easier for fintechs and banks to develop customized and data-driven products.

The incumbent major banks' dominant market position will likely protect them from tech headwinds. Collectively, the four major banks control about 75% of the Australian banking sector, giving them significant influence over the rollout of fintech innovations to the Australian population. Their profitable, mortgage-focused, operating model has lower susceptibility to tech disruption than overseas banking sectors that are more reliant on fees and noninterest income, in our view. Incumbent banks' high profitability also gives them room to invest in new technologies.

New players in the Australian banking sector have a significant head start on the technology front, with the incumbents weighed down by legacy systems for their core operations. However, incumbent banks are investing significantly to upgrade their systems. New entrants also face the challenge of building a sustainable customer base in the face of much larger, better resourced competition. Given the niche focus of many fintech market entrants, we see partnerships as more likely than an all-out disruption.

Australia's accelerated adoption of regulatory technology (regtech) solutions to manage nonfinancial risks is likely to be a key difference between Australia and other countries. In our view, the adoption rate is largely a product of Australia's current regulatory environment--post the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (Royal Commission) and the emergence of significant lapses in anti-money laundering controls--and Australia's leadership position globally in a number of regtech industry participants.

COVID-19: An Accelerator Of Tech Adoption

We believe the COVID-19 pandemic will accelerate the adoption of financial technology in Australia. For example, efforts to limit COVID-19 transmission have accelerated the rate of contactless payment adoption globally. Data released by payments provider Mastercard indicates the first quarter of 2020 saw a 40% global increase in contactless payments in grocery stores and pharmacies. The data also indicates that total contactless payment volumes grew at 2.5x the rate of noncontactless payment methods for the same period. Australia's contactless payments adoption was already well underway prior to the COVID-19 pandemic. According to the Reserve Bank of Australia (RBA) contactless payments made up close to 60% of all Australian payments (by number) in 2019, up from less than 10% in 2013. Similarly, social distancing and branch closures have significantly decreased foot-traffic through physical branches, accelerating adoption of online and app-based banking.

Temporary delays to development initiatives have somewhat offset the accelerating effect of COVID-19 on technology adoption. Australian banks and regulators have put a number of initiatives--such as open banking and new bank license issuance--on the back-burner to deal with the more immediate priorities created by the pandemic. Dislocation of global capital markets has also limited the growth of some new entrants. We believe these delays will be temporary and that the effect on customer preferences will be long lasting. Further, while banks face pressure on earnings under current conditions, we expect they will continue to prioritize investing in technology.

TRIP Analysis Shows A Low But Growing Risk For Australian Banks

We are illustrating our current views of disruption risk with our four-factor analysis of the Australian banking system's technology, regulation, industry, and preferences (TRIP; see chart 1) relative to international peers.

Chart 1

image

Preferences: Disruption Risk | High

Australia's banking customers tend to be quick adopters of financial technology, particularly if it provides additional convenience.

The rollout of contactless payments has been particularly successful in Australia--making up about 60% of point-of-sale (POS) transactions, and over 80% of card transactions as of December 2019, according to the RBA. POS transactions can be cash or noncash; contactless payments are a subset of the noncash component that uses near field communication technology to pay by tapping a phone or card on a payment terminal. The popular use of contactless payments in retail transactions--particularly since the COVID-19 pandemic--should aid fintech adoption, in our view, as they facilitate smartphone based digital wallets such as Apple Pay and Google Pay. Strong digital wallet adoption suggests a wide public trust in digital wallet providers and will likely drive increased uptake of future fintech products from known providers, in our opinion. Australia's contactless payments adoption is higher than many other developed countries such as France; where cash makes up over 50% of POS transactions. In our view, this reflects the Australian retail consumers' stronger preference for technology driven convenience. The U.K. also has strong user adoption with contactless payments at roughly 60% of POS transactions and cash usage at about 28%.

Consumer payments data suggest Australia's younger demographics have higher comfort with new technologies and a greater willingness to share their data with fintechs in exchange for convenience than older demographics. App-based BNPL loans are starting to replace credit cards as a source of low-denomination consumer loans, with millennials leading the transition. BNPL loans generally have an advantage over credit cards as most fees are borne by the merchant, rather than the consumer, and loan approvals are processed rapidly though a smartphone app. As with most technology-driven products, younger demographics have been quicker to adopt BNPL loans, sharing their credit history data with BNPL lenders to gain access to the lending platform.

Chart 2

image

Like most developed countries, Australia has an aging population when compared with, for example, China and Brazil. We believe Australia's age demographics will slow the adoption of fintech products, like BNPL loans, limiting potential for the kind of explosive fintech adoption seen in China. That said, Australia's population is still younger than those of Japan, Canada, and Western Europe.

Open banking will test Australian consumers' openness to freely sharing their data. The country's strong uptake of nonfinancial technology (such as social media and app-based ride sharing) indicates that the desire for convenience will likely outweigh privacy concerns for many. However, we believe public awareness about the rights of end users of open banking and the data protection mechanisms would likely play a key role in their decision to share data via open banking.

We believe that digital banks are unlikely to completely replace banks with a physical presence in the next five years. While a growing number of customer interactions are through digital channels, we believe a significant portion of the Australian population prefers in-person interaction for large financial decisions such as the purchase of their first home.

Regulation: Disruption Risk | Moderate

We believe Australia's regulatory environment is supportive of fintech development and competition in the financial services sector. In our view, Australia's regulators openly encourage innovation and see technology as a key mechanism of improving customer outcomes. However, they are still in the early stages of implementing key regulatory measures relative to international peers. For example, the implementation of European Union open banking regulations commenced in early 2018, while Australia's implementation is pending. That said, we consider that the regulatory policy is more supportive of innovation in Australia than Germany and Sweden where regulators do not actively promote financial innovation. Consequently, regulation will likely have a growing impact on tech disruption in Australia.

Both the Australian Prudential Regulation Authority (APRA; prudential regulator for the Australian financial services industry) and the Australian Securities and Investment Commission (ASIC; the Australian corporate regulator) have adopted concessional licensing programs: APRA's restricted authorized deposit-taking institution (ADI) license, and ASIC's fintech licensing exemption and informal licensing assistance program. These programs act as regulatory sandboxes, lowering the banking system's high barriers to entry and accelerating fintech adoption. These initiatives have materially affected the rate of new market entry. As an illustration, in the 10 years to July 2018, APRA issued 10 banking licenses (nine of which were to branches of overseas entities); and since May 2018 (the date restricted ADI licenses were introduced) APRA has granted 10 new banking licenses. Similarly, participants in ASIC's licensing assistance program progress through the Australian Financial Services or credit license application process 22% faster, on average, than applicants seeking a license without assistance. International cooperation is also an important element; ASIC has established cooperation agreements with 16 international regulators, including its counterparts in Canada, Singapore, and the U.K. Other initiatives include accelerators such as boot camps for startups and innovation hubs to promote the exchange of ideas.

Table 1

Regulatory Regime Comparison
Innovation Facilitators
Innovation Hub Accelerator Regulatory Sandbox
A place to meet and exchange ideas "Boot-camp" for start-ups, culminating in a pitch presentation Testing in a controlled environment with tailored policy options
Australia ASIC ASIC ASIC/RBA
Belgium NBB/FSMA
ECB SSM
France ACPR/AMF BDF
Germany BaFin
Italy BOI
Hong Kong SAR HKMA HKMA HKMA/SFC/IA
Japan BoJ/FSA
Korea FSC FSC
Luxembourg CSSF
Netherlands DNB/AFM DNB/AFM
Poland FSA
Singapore MAS MAS MAS
Switzerland Finma Finma
U.K. BoE/FCA BOE FCA
Source : BIS, BCBS-FSB survey, S&P Global Ratings.

We believe delays in Australia's open banking rollout are slowing the rate of fintech sector growth relative to open banking-enabled peers like the U.K. and Sweden. Australia's open banking rollout has been subject to multiple delays and is now running about 12 months behind schedule, with select data available from July 1, 2020. Ready access to customer data will allow fintechs to create products tailored to specific customer needs, bringing innovative financial products to Australian consumers. Open banking will also increase competition by giving all accredited parties access to what is currently incumbent banks' proprietary data, making it easier for customers to switch between financial services providers.

Australia is among global leaders in regtech adoption--alongside the U.K., the U.S., and Singapore--by number of active regtech industry participants. Given the Australian market's small size, this ranking demonstrates a particularly strong focus on regtech adoption. We believe this adoption rate is largely a product of Australia's current regulatory environment post the Royal Commission and the emergence of significant lapses in anti-money laundering controls. We note that ASIC has a specific mandate and federal government funding to promote the development and adoption of regtech solutions. ASIC has used this funding to promote a series of regtech initiatives, including use of data analytics to monitor compliance across financial promotions and advice products. ASIC is also developing interactive tools to increase the transparency of regulatory requirements.

Technology: Disruption Risk| Moderate

Implementing technology is a key hurdle for Australia's major banks as they rely on legacy IT systems for their core operations. On the positive side, the underlying technology (such as fiber networks, the New Payments Platform, and 5G) required for innovation is already available in Australia, similar to countries where it is also widely implemented such as Sweden and China.

Smaller regional and mutual banks face similar challenges, although the path will likely be easier for mutual banks that use cheaper off-the-shelf IT products and have generally stayed more up to date with core banking system upgrades than their major bank peers. Australia's network infrastructure is comprehensive and sufficient to meet the data needs of imminent technological developments; over 99% of Australia's population has mobile broadband access, including in remote areas.

We believe cloud migration and adopting a microservices software architecture style will be key to banks' future operating performance in all banking systems, including Australia. Cloud-based systems significantly improve system stability and lower infrastructure costs. Flexible system architecture increases the rate at which banks can update their systems to meet changing consumer needs, while also facilitating connectivity between banks and fintechs through easier application program interface (API) integration. Australia's neobanks have a significant head start over their incumbent rivals, with cloud-hosted core banking systems and flexible software that is easy to upgrade. However, the major banks are investing significantly to move away from their current legacy systems and will likely complete the transition without significant loss of market share, although this could be more than five years away. Microservices architecture has the benefit of allowing incumbents to move banking functions to the cloud in small pieces, reducing operational risk.

The Australian Stock Exchange (ASX) is at the forefront of adopting distributed ledger technologies (DLT) to replace its current electronic clearing and settlement system. The ASX's DLT-based CHESS replacement project has been in train for about two years now. In our view, ASX's DLT based record system will improve data accessibility, security, and integrity within the Australian financial system.

Industry: Disruption Risk | Low

Australia has a strong incumbent banking sector, which we believe will prove resilient to tech disruption. Australia has a high level of financial inclusion (over 99% of Australian adults have a bank account) and a developed retail banking sector that currently faces minimal competition from fintech players in their core activities of deposit taking and lending. Four major banks dominate Australia's banking sector, with a collective market share of 75% of domestic loans and deposits. A large number of small players share the balance. Given their dominant market position, the major banks have significant influence over the rollout of technologically enabled products to the Australian population.

Australian incumbent banks are profitable enough to make the required investment in technology. While ongoing tech investment will likely weigh on banks' operating revenue over the short to medium term, we believe that investments in technology will improve scale and efficiency in the long term. Australia's falling interest rate environment (with the cash rate now at a record low of 0.25%) leaves less room in bank margins to fund discretionary technology spending. While this adds to the challenges Australian banks face, we believe technological investment will remain a key expenditure item for banks looking to maintain their long-term business viability.

Chart 3

image

The revenue structure of Australia's major banks makes them less susceptible to fintech disruption than their international peers. We believe fintechs will initially focus on inefficiencies in the financial system, eroding fees and commissions by providing low-cost alternatives. Net-interest income makes up close to 80% of the Australian major banks' operating revenue, meaning fintechs would need to disrupt the banks' core deposit taking and lending operations to significantly erode their operating revenue. In the longer term, fintechs could use lower costs and enhanced features to disrupt the core lending and deposit taking market. However, in the short-to-medium term, we believe incumbent banks' trusted brands and experience meeting regulatory requirements will give them an advantage over fintechs. Incumbent banks are also partnering with fintechs to help them provide new services that lie outside their current product offering. We see partnerships as more likely than a full disruption of the existing model.

Chart 4

image

Australia's fintech sector remains small and is unlikely to threaten major banks' core lending operations in the near future. A number of tech-enabled digital banks (neobanks) have entered the Australian market in recent years. However, they are yet to gain significant traction relative to the incumbent banks, with a collective market share of less than 0.05% of system lending as of Dec. 31, 2019.

BNPL loan providers have made a dent in the credit card market, with BNPL loans up to about 3% of credit card volumes in 2019. If they continue to grow in prominence, it could weigh on credit card fees and margins but this is still some way off, in our view.

Chart 5

image

Apple and Google are also encroaching on the Australian payments sector. However, as in other countries, they are staying away from the lending and savings side of banking due to regulatory hurdles. Asian big tech players have recently begun to make some inroads into the Australian financial sector with Chinese tech giant Tencent's purchase of a 5% stake in Afterpay--Australia's largest BNPL provider.

The major banks have significant influence over the rollout of financial technology to Australian consumers. For example, consumer adoption of Australia's New Payments Platform (NPP) initially commenced more slowly than industry projections because a number of major banks were slow to deliver the new services to their customers. This delay was despite many of Australia's smaller banks being quick to roll out the service, with more than 50% of them live on the NPP from day one. The major banks are also collaborating to meet the needs of Australian consumers and limit disruption from new market entrants. Three of the four major banks (Commonwealth Bank of Australia, National Australia Bank Ltd., and Westpac Banking Corp.) partnered to create Beem It--a secure mobile payment app that allows users to send, receive, and split real-time payments using their phone number or a QR code. Beem It now has over one million app downloads, leveraging the combination of tech-enabled functionality and trust in the major banks' security.

Open banking will accelerate the rollout of technology to consumers by making it easier for fintechs and banks to develop customized and data-driven products. Open banking will give fintechs easy access to data, which is currently only held by banks, going some way to eroding the financial sector's high barriers to entry. Open banking data will be available to any company that meets the accreditation requirements and has permission from its end users. However, fintechs looking to take on the major banks will not only face the banks themselves, but also the fintechs owned by bank venture funds. Each of the Australian major banks has its own venture fund. These funds collectively own stakes in many of Australia's fintech startups, providing them with capital, legal, and regulatory advice, and potentially access to open banking data. Bank-owned startups will likely be able to access open banking data at an earlier development stage than others by leveraging their parent bank's accreditation, meaning they don't have to build data security infrastructure, internal dispute resolution processes, or take out additional liability insurance. Bank-owned fintechs provide a means for incumbent banks to mitigate some of their current technology limitations and the long timelines associated with the technology transformation of a large organization.

Proptech in property settlement and post transaction services is also an important fintech area developing in Australia. In 2010, the Council of Australian Governments formed Property Exchange Australia (PEXA), a national online system providing electronic settlement of property transactions--electronic conveyancing (e-conveyancing). PEXA comprises a network of almost 9,000 members with more than A$750 billion worth of property across 4.6 billion property transaction successfully transacted online with PEXA. In late 2019, the ASX-backed e-conveyancing service Sympli started executing e-conveyancing transactions in low volumes. In our view, growth in e-conveyancing services will make the property settlement process more efficient and lead to better customer outcomes. We do not, however, think that it will contribute to disruption in the retail banking sector.

Australian Banks Face A Low But Growing Risk From Technological Disruption

Overall, we believe Australia's incumbent banks are well positioned to weather the winds of technological disruption and do not expect technological disruption to cause downward rating pressure in the next two years. However, susceptibility to disruption varies within the Australian banking sector. We believe the major banks have the resources to upgrade their technology systems as required. Similarly, many of Australia's smaller mutual banks are in a good position as they have relatively up to date systems and use low cost off the shelf products--although some mutual banks are lagging peers. Some of Australia's regional banks face a more significant challenge; like the major banks, they have bespoke legacy systems but they do not have the same large resource base with which to build new systems.

Risks are mounting, with accommodative regulation and strong customer demand for technology pushing the Australian banking sector forward. However, the incumbent banks are well placed to defend their position. In the short-term, we see limited risk of disruption as incumbent banks' have superior resources and a large well-established customer base. In the longer-term, factors such as open banking could result in a more price-driven, brand-insensitive financial sector, where consumers meet most of their financial needs through tech-driven intermediaries. We also expect technological investment needs will be a driver of further consolidation among Australia's smaller incumbent banks as growing costs and competition from new entrants place further pressure on margins.

Related Research

  • The Future Of Banking: Research By S&P Global Ratings
  • Tech Disruption In Retail Banking: Singapore Banks Are Front-Runners In Digital Race, June 3, 2020
  • Tech Disruption In Retail Banking: Hong Kong's Large Banks Are Pioneering The City's FinTech Development, June 3, 2020
  • Tech Disruption In Retail Banking: Better Late Than Never For Japanese Fintech, Feb. 5, 2020
  • Tech Disruption In Retail Banking: Brazilian Banks Rise To The Challenge, Feb. 3, 2020
  • Tech Disruption In Retail Banking: U.K. Banks Embrace The Tech Race, Nov. 14, 2019
  • The Future Of Banking: Will Retail Banks Trip Over Tech Disruption? May 14, 2019
  • Tech Disruption In Retail Banking: German Banks Have Little Time For Digital Catch-Up, May 14, 2019
  • Tech Disruption In Retail Banking: China's Banks Are Playing Catch-Up To Big Tech, May 14, 2019
  • Tech Disruption In Retail Banking: Swedish Consumers Dig Digital--And Banks Deliver, May 14, 2019

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