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Tech Disruption In Retail Banking: Singapore Banks Are Front-Runners In Digital Race

(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. We republished this article on July 16, 2020, to reflect minor editorial changes.)

Singapore banks are turning enemies into allies. Doomsayers have predicted the end of banking as we know it and hailed fintech as the most important innovation since the internet boom. But Singapore banks are not being annihilated by tech start-ups. Instead, they are joining hands with innovators to seek win-win outcomes.

The case for digital banking services in Singapore has become stronger due to COVID-19. A record number of digital banking transactions are taking place during the COVID-19 outbreak, pointing to a strong acceleration in fintech adoption. The number of customers who switched to digital banking have grown significantly, including those in the 60-80 age group. For example, more than 100,000 DBS Bank customers made their debut digital transactions from January to March 2020. Evidently, consumers who were initially resistant to digital channels are adopting out of necessity during these challenging times. The volume of digital payments has also increased significantly.

Singapore encourages innovation and adoption of digital banking, while maintaining marketing stability and limiting excessive disruption in the regional banking industry. The banks are alive and well, based on S&P Global Ratings' four-factor analysis on technology, regulation, industry, and preferences (TRIP).

From a bank's perspective, the advantages of fintech are straightforward. Large banking conglomerates are slow and held back by tradition and compliance to make an internal culture of innovation work. Tapping into an external talent pool of young minds is more efficient and much faster. Fintech partnership represents a ready and cost-efficient source of innovation that allows banks to preserve their relevance or even enhance their service standards to customers.

The tech companies benefit too. They have innovative ideas but don't always understand the heavily regulated banking sector or have the funding. Also, banks provide access to a huge anonymized customer database--a valuable commodity in the digital world. This enables tech companies to apply their ideas and technology for fintech applications, such as robo-advisers or credit platforms.

With the cooperative approach, banks can safeguard their future against digital disruption. Banks' fintech investments will ensure that current and future dominating technologies in banking remain under their control.

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Industry: Disruption Risk | Low (2)

Dominance of the large domestic banks create high barriers to entry

The Singapore banking industry is saturated. It is highly concentrated and dominated by three main players-- DBS Bank Ltd., Oversea-Chinese Banking Corp. Ltd. (OCBC), United Overseas Bank Ltd. (UOB)--which together have about 60% of the market in domestic customer loans and deposits.

The banking sector started the transformation process several years ago, shifting from traditional bank branches to online and digital interactions, in response to changing customer preferences. In fact, traditional banks, insurers and wealth managers are disrupting their own propositions, by offering digitally accessible and technology-forward services. Banks are also collaborating with fintechs, making it difficult for new entrants to gain a foothold.

UOB has partnered with several fintech companies. Grab is one example. Grab will offer UOB card privileges directly on its mobile app, such as higher rebates for Grab transactions and loyalty programs. DBS is Go-Jek's primary partner for the ride-hailing company's operations in Singapore. OCBC is promoting fintech innovation through its Open Vault OCBC (TOV) initiative.

The partnership of banks with tech companies will expand digital offerings and cross-selling opportunities. Digital banks could complement traditional banks in the under-served small and midsize enterprise (SME) space, particularly in the higher risk segments overlooked by banks. We expect the new digital banking licenses (see the section titled "Regulation: Disruption Risk | Moderate") to likely to create new partnership opportunities between banks, non-bank financial institutions, fintechs, and even corporates.

We view the Monetary Authority of Singapore (MAS), the regulator, as supportive of greater collaboration between fintech companies and financial institutions. Our view is based on recent MAS initiatives taken such as developing research platforms for fintech start-ups, which we believe will enhance transparency, increase confidence and lead to faster decision-making among firms. The launch of Sandbox Express in August 2019 also highlights the strong commitment of the regulator toward innovation and encourage development of new financial products in the near future.

Fintech start-ups will benefit from incumbent banks' strengths: brand recognition, established customer bases, strong balance sheets, regulatory experience, and physical branches with human interaction, which will remain a critical part of banking. Meanwhile, traditional banks stand to gain from fintechs' new perspectives, market intelligence, and technical expertise, which are hallmarks of nimble, innovative start-ups.

In our opinion, Singapore banks are not trying to drive fintechs out of the business landscape; instead the banks want to discover areas where they should develop internally and others where they should partner with fintechs. We believe the major Singapore domestic banks and large qualifying full banks are best positioned to thrive in the fintech era. They have two necessary advantages: (1) the required resources to invest in technology and acquire start-ups; and (2) a rich pool of customer data to harness the technology into a commercially viable product or app.

Technology: Disruption Risk | Low (2)

Singapore banks are well-positioned digitally

Singapore is well-positioned as a fintech hub, given its infrastructure capabilities, extensive smartphone penetration, and supportive regulatory environment. In addition, Singapore ranked top in the CISCO Digital Readiness Index published 2019. Within the Association of Southeast Asian Nations (ASEAN), Singapore stands out as having solid infrastructure and extensive smartphone penetration that favors digitization. The country's average income is also much higher than that of its ASEAN neighbors, and makes a compelling case for payment and cashless service providers.

Banks have been investing heavily in technology and continue to do so. They also have embraced digital banking by changing the culture and mindset of employees, revamping IT systems, and developing innovative tools such as mobile payment solutions, automation of processes, and use of biometrics in their existing processes. On top of this, banks are incorporating advancements in big data analysis and artificial intelligence to better understand and service their customers' needs, preferences, and expectations.

Most fintech newcomers are entering niche segments of the wider financial industry. They primarily provide innovative financial services targeted at the retail business, such as payments solutions, online banking, and peer-to-peer lending. This new wave of technological development has not revolutionized the entire financial landscape yet. Financial institutions have remained dominant and that means the upcoming virtual banks may have less room to disrupt.

Improving customer experience to maintain market share and retain existing customers is the biggest reason for investing in fintech. This typically involves using digital channels to cut transaction times and artificial intelligence to enhance customer experience. DBS Bank completed in February the first digital trade financing transaction on the Networked Trade Platform. The platform, developed in late 2018, has accelerated the digitization momentum in the country. Fintech could also improve banks' cost-to-income ratio, given digital customers' lower servicing costs, which make them theoretically more profitable than traditional customers. In practice, material cost savings have yet to emerge.

On the flip side, the big Singapore banks that began their digital journey several years ago have yet to demonstrate significant cost savings or income boost. These benefits will accrue mainly from branch and staffing reductions, which will likely need sizable investments in digital innovation or solutions and information technology infrastructure. For now, the profitability and efficiency ratios of the Singapore banks we rate have remained flat, and they have largely retained existing traditional infrastructure such as ATMs and branches.

Expectations of cost efficiency are currently being driven by a shift from traditional to digital customers, not branch reduction per se. In Singapore, bank management guidance is toward branch restructuring rather than branch closure, such as having smaller branches with fewer counter staff and more self-service kiosks. In contrast, banks in Thailand have been consistently closing branches as they build their digital capabilities.

We believe Singapore banks are maintaining branches to protect their deposit market share. Singapore has an ageing population with a sizable pool of customers that rely on branch banking. Although it is a diminishing pool of customers, deposits from the older demographic are highly inelastic and sticky, which banks prefer. Maintaining deposit market share is crucial for banks to see the benefit of higher rates flow through to net interest margins. Also, cutting branches and headcount is often a sensitive topic locally, and we believe rationalization will be incremental and protracted.

Regulation: Disruption Risk | Moderate (3)

Regulation strikes a fine balance between innovation and measured disruption

In our opinion, the MAS is progressive, and has thus far succeeded in achieving a fine balance between preserving financial stability and promoting innovation. The government is granting of up to five new digital bank licenses. That will increase banking sector competition, but is unlikely to threaten the dominance of the country's three largest banks--DBS Bank, OCBC, and UOB.

The COVID-19 outbreak has delayed the award of digital licenses in Singapore--originally slated to be announced in June. The Monetary Authority of Singapore (MAS) extended the assessment period for its decision to the second half of 2020. In January, the regulator revealed it had received 21 applications for the licenses: seven were for digital full bank licenses, and the remaining applications for digital wholesale bank licenses.

Singapore's first digital banking licenses could increase competition in an already saturated market, but domestic banks with established franchise are well placed to defend their market share. The regulator is committed to preventing value-destructive competition by limiting the new entrants to under-served markets. These are likely lower-income individuals or start-ups that could not meet traditional banks' credit requirements.

We believe regulatory risk is balanced as policymakers keep a close watch on financial trends that could lead to chaotic disruption in the banking industry. At the same time, regulators are pro-innovation, in our view.

Singapore is a matured market with very high banking penetration, and it is likely that digital banks will carve out a niche in the under-served segment before expanding to other markets. Segment strategy is crucial. A digital bank, being relatively small, is unlikely to be everything to everyone, like the universal banking model of the large domestic banks. The ability for a digital bank to target correctly and iterate unconventional revenue models are key.

China had taken a similar soft-touch approach in regulating the fintech industry in the past, but has become more stringent in recent years. In China, innovations are driven by big tech companies rather than banks, and some of these tech-giant initiatives have grown large enough to pose systematic risk to the financial system. For example, Ant Financial's Yu'e Bao fund has become the biggest money market fund in the world, and could pose settlement, liquidity, and systematic risks. This has prompted the regulator to tighten its oversight. We don't expect the MAS to take this path, given tech firms have yet to establish a local dominance in Singapore.

Preferences: Disruption Risk | Low (2)

Customers embracing fintech, but loyalty to domestic incumbents remains strong

According to Ernst & Young Global FinTech Adoption Index 2019, China and India top 27 countries and regions in the measure at 87%. Singapore, Hong Kong, and South Korea's adoption has reached 67%--ahead of the global average of 64%. Most 39 year olds and under are highly adaptive to digital and mobile devices, making them online lenders' key target customers. Customers are also embracing mobile banking. Mobile penetration rate is very high at 158% as of November 2019, according to the Infocomm Media Authority of Singapore, with a sizable proportion of the population having more than one mobile subscription.

On the other hand, Singapore has an aging population. With one of the highest life expectancies and lowest fertility rates in the world, Singapore is on the cusp of a pivotal demographic shift. Among the ASEAN member states, the country already has the oldest demographics. Based on projections from the United Nations (UN), 47% of Singapore's total population will be aged 65 years or older in 2050. This has important implications for traditional banking versus digital channels adoption, noting that Generation X and Baby Boomers have lower digital propensity than Millennials and Generation Zs. The older population have a lower propensity to experiment with new alternative banking channels and platforms, and are more likely to remain loyal to the large domestic incumbents.

According to PricewaterhouseCoopers' Digital Banking Customer Survey, 40% of Singapore respondents indicate that they will only consider opening an account with a digital bank once it is popular and successful; they will not be the first one to open an account. We believe digital banks are not likely to replace existing banking relationships for most customers. This is an important point for digital banks as customers are more likely to use their digital bank as a supplementary account as opposed to switching.

We believe trust is the top barrier to using a fintech challenger as opposed to traditional financial institutions in markets such as Singapore. Thirty-four percent of customers do not trust digital banks with their data. One in three customers do not trust that digital banks will be financially stable. Although tech companies are more agile in developing their systems, they are not as competitive on the trust front as traditional banks, which have been building trust among its customers for decades.

In our view, fintech companies that focus on technology and transactional efficiency alone will not last long in the current Singapore environment. For activities other than digital payments, retail banks with physical bank branches continue to be the primary choice for customers, particularly when applying for personal and business loans, and seeking investment advice. Customer behavior in Singapore suggests that this is likely to continue. Until tech companies earn the customer's trust, they do not own the customers.

Related Research

This report does not constitute a rating action.

Primary Credit Analyst:Ivan Tan, Singapore (65) 6239-6335;
ivan.tan@spglobal.com
Secondary Contact:Rujun Duan, Singapore + 65 6216 1152;
nancy.duan@spglobal.com

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