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The Future Of Banking: Can Digital-Only Banks Crack Malaysia?


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The Future Of Banking: Can Digital-Only Banks Crack Malaysia?

Malaysia has an unprecedented opportunity to digitalize its banking services with new lenders poised to enter the market. S&P Global Ratings doesn't expect an immediate shakeup to the competitive landscape; instead, incremental changes are likely to lead to a more dynamic, diversified industry. But not all players will benefit equally. Of the eight local banking groups and a handful of foreign banks that dominate the market, the two largest appear best placed to fend off the new competition. That's because Malayan Banking Bhd. (Maybank) and CIMB Group Holdings Bhd. already have established digital infrastructure, diversified earnings profiles, and large customer bases.

Fertile Ground For Fintech

Malaysia's market infrastructure offers a highly supportive environment for digital banks and fintech to flourish, in our opinion. Internet and mobile phone penetration rates are among the highest in the Association of Southeast Asian Nations (ASEAN), and mobile and internet banking were gaining popularity even before the pandemic. The regulatory framework is also favorable. Bank Negara Malaysia, the central bank and regulator, launched the Real-time Retail Payments Platform in 2019, granting access to all licensed banks and e-wallet providers. In addition, Bank Negara has run a regulatory sandbox since late 2016 and announced its final licensing framework for digital-only banks in December 2020. Up to five licenses will be granted by the first quarter of 2022.

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That said, we expect the Malaysian fintech market to remain fragmented and highly competitive for the next three to five years. The market dynamics are similar to those of other ASEAN economies. For example, 48 licensed e-money operators compete in the digital payment/e-wallet space, the largest fintech sub-market in the country. Active fintech players in Malaysia include international names such as PayPal, Alipay, and WeChat Pay, as well as regionally or locally based unicorns such as Grab, Boost, Touch'n Go, and AirPay.

Digital-Only Banks To Remain Niche Players For Now

We see significant opportunities for digital-only banks in Malaysia, but they come with particular operational and credit challenges. Financial inclusion for under-served and unserved segments of the economy has been a feature of Malaysia's regulatory push for digital-only banks. Based on World Bank estimates, 25% of the Malaysian workforce were employed in part-time or freelance work in 2020--a number that could well rise on account of the pandemic's disruption to the job market for at least the next 12-18 months. Gig economy workers have largely been shunned by traditional banks due to the difficulty of obtaining collateral and assessing the cash flow and payment ability of such borrowers.

Digital banks will find it equally tough when trying to take on new customers from these segments. This makes it important to find alternative data sources to carry out due diligence, preferably knowledge accumulated in their own ecosystems prior to entering the banking business.

The two successful full digital bank applicants in Singapore serve as examples. Grab has 40,000 active private-hire drivers, 6,000 GrabFood riders, and more than 12,000 GrabFood and GrabMart merchants in the city-state. Its consortium partner Singapore Telecommunications Ltd. (Singtel) is the country's largest telecom operator, with 4.3 million mobile subscribers and a market share of more than 50%. Another full digital bank license holder is the SEA Group, the parent of regional e-commerce platform Shopee. Monthly traffic to Shopee's Singapore website was around 14.1 million hits in the fourth quarter of 2020, having increased significantly during the pandemic. We believe both companies can use the wealth of proprietary customer data collected on their platforms on consumers and merchants to drive initial growth and support credit underwriting of their planned digital banks.

In our view, successful applicants for digital bank licenses in Malaysia will likely share similar business profiles and have strong digital competency in their existing domains. But given the much lower capital threshold required--Malaysian ringgit (MYR) 300 million compared with Singapore dollars (S$) 1.5 billion--smaller fintech companies with strong technology are also well placed to succeed.

Nevertheless, digital-only banks won't immediately threaten established lenders. In such a competitive market, new entrants face an uphill battle. In addition to having to carry a much riskier portfolio, new players face many regulatory and operational constraints such as asset ceilings, stringent capital requirements, higher compliance and operational costs, and a lack of scale and customer trust. The credit cycle triggered by COVID has also shown how difficult it can be for small digital banks to stay afloat during a crisis. Even if all five digital banks navigate the three- to five-year foundational phase laid out in Bank Negara's licensing framework, we forecast that their combined market share is unlikely to reach 0.5% of total banking sector assets.


Covid-19 Widens The Digital Gap Among Malaysian Banks

COVID-19 should further increase the gap among big and small Malaysian banks in terms of technological ability. Two clear leaders on this front are Maybank and CIMB. Both had built up omnichannel business models before the pandemic through years of heavy investment in technology. They have sought to cooperate with fintech players, for example by running open application programming interfaces and sandboxes, and by experimenting with new products based on technologies such as blockchain, machine learning, and data analytics.

The two companies also own stakes in promising fintech ventures in Malaysia. Maybank acquired 30% of Gpay Network (a subsidiary of Grab in Malaysia) and formed a strategic partnership with the fintech parent, while CIMB holds a 51% stake in TNG Digital, a joint venture set up with Alipay. Touch'n Go, run by TNG Digital, is one of the most popular mobile payment platforms in Malaysia. CIMB has also launched digital-only banks in the Philippines and Vietnam, where it currently has a light physical presence--a similar strategy to that of Singapore competitors DBS Bank Ltd., which operates digital banks in India and Indonesia, and United Overseas Bank Ltd., which has launched mobile-only bank TMRW in Indonesia and Thailand. Dampened earnings amid the pandemic could temporarily constrain these technology investments, but we don't expect substantial or permanent cuts to such strategically important IT budgets over the next three to five years.

In sharp contrast, small local banks such as Affin Bank Bhd. and Alliance Bank Malaysia Bhd., which already lag bigger peers in terms of digital innovation and products, face a far greater challenge in mobilizing the resources needed to stay competitive as the pandemic recedes.

In our view, the very strong niche that Public Bank Bhd. has established in the small and midsize enterprise (SME) and retail markets has facilitated very low operating expenses and reined in spending on technology in recent decades. The bank's cost-to-income ratio has ranged between 32% and 35%, compared with the industry average of 43%-46%. However, we believe the bank will have to step-up on its spending on technology to retain market dominance, given the increasing preference for digital services and innovative products among younger customers and more intense competition in wealthy segments.

We see further room for even the leading Malaysian banks to increase investment in technology. The gap with the most digital-focused banks in the region is still significant. For example, technology investment (excluding human resources) at DBS was S$1.09 billion (MYR3.354 billion) in fiscal 2020 (ended Dec. 31, 2020), roughly 17% of its overall operating expenses. China-based WeBank Co. Ltd., 30% owned by Tencent Holdings Ltd., committed 25% of its operating expenses to research and development in 2019, and over 50% of its headcount works on IT, meaning it has a completely different employee skill profile to traditional banks.

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What's Next?

While the disruption of the banking sector should be gradual, the earnings of existing players will be strained. Malaysian banks have operated in a lackluster growth environment for many years, with the corporate client base expanding little as companies seek to reduce debt or opt for direct financing in capital markets. The stagnation of corporate lending has pushed local banks to focus on SMEs and retail credit. The intense competition, together with the low-interest rate environment of the past decade, has caused a consistent decrease in net interest margins. We expect the situation to worsen with the entry of digital banks and fintech players, which could increase deposit competition and drive up funding costs. Established banks also risk losing out on fee income, especially in areas such as payments, remittances, investment advisory, wealth management, and bancassurance.

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Big banks will likely have to rethink the rationale of industry consolidation, as well. Several attempts to further consolidate the country's eight banking groups have failed in the past decade. We believe the motivation for such industry consolidation has been greatly reduced for the likes of Maybank and CIMB with the development of the fintech sector. Branch networks are no longer such an important factor in M&A decisions, especially in a market with mature branch coverage like Malaysia. Instead, optimizing existing market and product ecosystems, gaining access to previously inaccessible customer groups, and solidifying core customer relationships are priorities when considering inorganic growth opportunities. Cross-sector investments, such as in successful fintech companies, are set to become more alluring than acquiring small local banks, in many cases.

Related Research

Malaysian Banking Sector Update: Asset Quality Recovery Delayed Beyond 2021, April 12, 2021

This report does not constitute a rating action.

Primary Credit Analyst:Rujun Duan, Singapore + 65 6216 1152;
Secondary Contacts:Ivan Tan, Singapore + 65 6239 6335;
Geeta Chugh, Mumbai + 912233421910;

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